Informist, Monday, Mar 11, 2024
--Govt source: Revenue dept working on GST compensation cess report
--Govt source:Mulling tax options beyond compensation cess end date
--CONTEXT: GST compensation cess scheduled to end on Mar 31, 2026
--Govt source: Mulling 3 options for post-compensation cess scenario
--Govt source: Must balance protecting revenue, avoiding excessive tax
--Govt source: GST Council to take up report on cess at next meet
--CONTEXT: GST Council likely to hold next meeting in July
By Sagar Sen and Priyasmita Dutta
NEW DELHI - Two years ahead of the phaseout of the cess for compensation of states for revenue losses on account of the rollout of goods and services tax, the finance ministry's Department of Revenue has started weighing its options on the path ahead. The key consideration for the government is to strike a balance between protecting revenues and avoiding excessive taxation on consumers, a senior finance ministry official said.
The various models being deliberated by the ministry will be presented before the GST Council, which will ultimately decide on the course of the action to be pursued beyond Mar 31, 2026, when the compensation cess--levied on some top tax slab items mostly from the 'sin' segment--is slated to be removed, the official said.
"The department has already started making projections and analysing different options that can be looked at by the council at the next meeting," the official told Informist. The GST Council is likely to hold its next meeting in July, once the General Elections are over, Informist had reported last week.
The main idea behind the revenue department's efforts is to draw up the revenue impact on states as well as Centre in each of the scenarios under consideration. This is to enable the GST Council to make an informed decision regarding the treatment of the compensation cess after March 2026.
There are three main alternatives that the finance ministry is examining, each with its own set of considerations. The decision entails so much complexity that there is a possibility that the GST Council may form a separate group of ministers to look into the matter, the official said.
One of the options is to do away with the compensation cess after March 2026 after repaying the outstanding GST-related debts and to distribute any residual collections to states, the ministry official said. This would be in line with the recommendations of the 15th Finance Commission.
The mechanism for discontinuation of the compensation cess could be a contentious point in the ongoing tug-of-war between the Centre and states regarding the sharing of tax revenues.
A second possibility is to subsume the cess in the highest GST tax rate bracket, which is currently 28%. However, some of the items currently in this bracket, such as smaller vehicles and aerated beverages, should logically be kept out of the increased tax rate, the official said. Besides, higher tax rates are not ideal, the official added.
The third option, which is the most unpopular among states, is to stop GST compensation levy as soon as the fund needed to clear GST-related debts is accrued. The official said the states are not at all comfortable letting go of the revenue coming in from the compensation cess.
In order to convince states to come on board to adopt the GST regime in 2017, the Centre had promised to protect 14% revenue growth for states for the first five years by levying a cess on certain luxury and sin items such as tobbacco items and aerated drinks. Originally, the collection of GST compensation cess was to be discontinued in June 2022.
However, when the GST mop-up as well as cess collections dwindled during the COVID-19 pandemic, the Centre borrowed an additional 2.69 trln rupees from the market in 2020-21 and 2021-22, and passed on these funds to states as back-to-back loans to partly meet the shortfall in collections. These loans were to be repaid from the GST compensation cess fund. So far, the government has redeemed 781 bln rupees worth of bonds in 2023-24, and a total of 1.91 trln rupees worth of such bonds are scheduled to mature in 2025-26 and 2026-27. The GST Council extended the compensation cess till March 2026 to pay interest and repay the loans.
In the Interim Budget for 2024-25 presented on Feb 1, the government said it would dip into the compensation cess fund to repay 1.24 trln rupees worth of GST-related loans during the year. Deducting this, the government will be left with an estimated repayment of around 670 bln rupees.
In an interview given to Informist after the Interim Budget for 2024-25 Finance Secretary T.V. Somanathan had said the government wants to expedite repayment of the GST-related debt, as it wants to save on the interest cost.
CESS CONUNDRUM
In its last meeting held on Oct 7, the GST Council had decided to start looking into the matter of the compensation cess in preparation for the discontinuation deadline of March 2026. "This is a complex matter, and it is expected the entire meeting will be focussed on simply navigating the roadmap ahead on what becomes of this cess after servicing the loans," the official said.
By definition, a cess is levied for a specific purpose and the collections can be deployed only for that specific use, which in this case was to compensate states for revenue losses in the initial five years of GST. Going strictly by this rule, the compensation cess should not be levied once states have been compensated. However, it will be difficult to wean the Centre as well as state governments off this additional source of revenue as the cess mop-up has largely been "normalised" as a revenue stream, top revenue department officials told Informist.
The matter gets more complicated if one factors in the likely mismatch between the GST-related liabilities and the collections in the compensation cess fund, the latter expected to far outstrip the former. The government aims to collect 1.45 trln rupees as GST compensation cess in the current year and another 1.50 trln rupees in 2024-25.
In addition to the GST-related bond repayments, 430.55 bln rupees from the compensation cess fund will be given to states in the current financial year against their previously incurred revenue loss. Since the transfer of dues is subject to furnishing the state accountant general's certificate, some of these claims are still trickling in as and when states obtain the requisite certificates. Another 140 bln rupees will be paid as interest on GST-related debt, taking the total outgo from the fund during 2023-24 to 1.35 trln rupees.
In 2024-25, the Centre is looking to clear compensation dues of around 130 bln rupees to states once they provide the state accountant general's certificate. Another 159 bln rupees is likely to be paid as interest on GST-related debt. Including the GST-related bond repayment, the total outgo from the compensation fund next year works out to be around 1.53 trln rupees.
Going by the above numbers, the inflow and outflow from the GST compensation fund will be broadly matching till next year, with a net estimated surplus of just above 69 bln rupees. However, the mismatch will arise in 2025-26, when the amount of bonds outstanding as well as their interest liability comes down.
After the pandemic, compensation cess collections have been growing at an average rate of 15.4% annually in the last four years. By extrapolating this growth to 2025-26, the mop-up from compensation cess for the year can be estimated at around 1.73 trln rupees. At the same time, interest costs during the year can be estimated to fall to 70-80 bln rupees as the total outstanding GST-linked debt will fall to around 670 bln rupees, less than half of the year-ago amount. As a result, there is a likelihood that around 1 trln rupees excess will remain in the fund after meeting all payment obligations.
According to the Goods and Services Tax (Compensation to States) Act, 2017, "50% of the amount remaining unutilised in the fund at the end of the transition period shall be transferred to the consolidated fund of India as the share of Centre, and the balance 50% shall be distributed amongst the states in the ratio of their total revenues from the state tax or the Union territory goods and services tax, as the case may be, in the last year of the transition period."
By this formula, the Centre and all state governments combined will end up with an estimated 500 bln rupees each if the GST Council chooses to continue the cess levy till the scheduled end date, beyond the repayment of dues.3
On the face of it, discontinuing the compensation cess levy beyond March 2026 may seem like an uncomplicated choice. But it will also dash states' hope of the GST Council ever giving a nod to compensate them for revenue losses suffered beyond June 2022.
Since the revenue growth for most states remained short of 14% well beyond June 2022, many of the Opposition-ruled states have been demanding compensation for revenue losses beyond the original timeline of five years even as the distribution of any excess money left in the compensation fund may make up for some of those shortfalls.
The Centre, on the contrary, believes that the states are now comfortably placed in terms of state GST collections and do not need any additional support. End
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