The GST compensation mess

 *The GST compensation mess*:

On Dassera day, Maharashtra CM Uddhav Thackeray stirred a hornets nest by alleging that the Centre was not paying ₹ 38,000 Cr of GST compensation the Centre owes Maharashtra.

Under the GST (Compensation to States) Act, states are assured compensation for the gap between revenues at a compounded growth rate of 14 per cent over the base year revenue of 2015-16 and the actual revenues from GST for five years ending June 2022 through levy of cess on demerit and sin goods.

The story so far: The 41st meeting of the GST Council was held on August 27 with the singular agenda of finding a solution to the question of how best to ensure that the compensation payable to the States as part of the implementation of the Goods and Services Tax continues to be paid. 

The background for the meeting was the fact that the Centre and the States were cognisant of the substantial impact on GST collections from the last fiscal year’s economic slowdown and more recently the lockdowns and COVID-19-related curbs that have severely shrunk the economy. 

At the meeting, Finance Minister Nirmala Sitharaman stated that the GST Compensation Fund was projected to face a shortfall of about ₹2.35 lakh crore at the end of the current financial year and suggested two borrowing options that the States could choose from to bridge the shortfall.

What is the GST compensation?

The Constitution (One Hundred and First Amendment) Act, 2016, was the law which created the mechanism for levying a nationwide GST. Written into this law was a provision to compensate the States for loss of revenue arising out of implementation of the GST. 

The adoption of the GST was made possible by the States ceding almost all their powers to impose local-level indirect taxes and agreeing to let the prevailing multiplicity of imposts be subsumed under the GST. 

While the States would receive the SGST (State GST) component of the GST, and a share of the IGST (Integrated GST), it was agreed that revenue shortfalls arising from the transition to the new indirect taxes regime would be made good from a pooled GST Compensation Fund for a period of five years that is set to end in 2022. This corpus in turn is funded through a compensation cess that is levied on so-called ‘demerit’ goods. The computation of the shortfall — the mechanism for which is spelt out in Section 7 of the GST (Compensation to States) Act, 2017 — is done annually by projecting a revenue assumption based on 14% compounded growth from the base year’s (2015-2016) revenue and calculating the difference between that figure and the actual GST collections in that year.

For the 2020-21 fiscal year, the revenue shortfall has been anticipated at ₹3 lakh crore, with the Compensation Fund expected to have only about ₹65,000 crore through cess accruals and balance to pay the compensation to the States.

With the Centre agreeing to borrow ₹1.1 lakh crore from a special window of the Reserve Bank of India and on-lend it to the states, some of the seven states that are yet to agree to the plan may now sign on.

The officials added that the Goods and Services Tax (GST) Council could, based on revenue flows over the next few months, review the quantum of borrowing.

The only contentious issue left is the remaining ₹1.25 lakh gap in compensation. As GST revenues increase , this might end up being only ₹70,000 crore in 2020-21 (in addition to the ₹1.1 lakh crore).

“The Centre’s decision to borrow from the market and pass the same to the states as a back-to-back loan is in the spirit of cooperative federalism. That addressed the immediate concern. Later, GST Council may always review the financial position and take necessary steps on a similar principle.

The seven dissenting states are Chhattisgarh, Jharkhand, Kerala, Punjab, Rajasthan, Telangana and West Bengal.

On August 27, the Centre gave states the choice of borrowing ₹97,000 crore (the shortfall resulting from GST implementation issues) without having to pay principal or interest or the entire ₹2.35 lakh crore compensation gap (including that arising from the Covid-19 pandemic) projected for this fiscal year. 

The ₹97,000 crore amount was subsequently raised to ₹1.1 lakh crore on October 5. 

Some states objected and insisted the borrowing would have to be done by the Centre.

The GST Council is a federal body, chaired by the Union finance minister, and whose members include the finance ministers of the state. This is the body that decides tax rates and other issues related to GST. 

The Finance Minister has assured state governments that the entire arrears of compensation will “eventually” be paid to states. She thanked states for their “collaborative” approach that resulted in a “constructive and practical solution” to this issue of compensation cess.

The GST Council, on October 5, unanimously extended the levy of compensation cess beyond June 2022 till such time the states are compensated for their assured revenue shortfall. At the time the new tax regime was introduced in July 2017, the GST law assured states a 14% increase in their annual revenue for five years (up to June 30, 2022); any revenue shortfall should be made good through the compensation cess levied on luxury and sin goods such as liquor, cigarettes, aerated water, automobiles, coal and other tobacco products. The cess would have ceased to exist after June 30, 2022, without the Council’s decision to extend it.