GST 2.0 Reforms: India Moves to Two-Rate Structure

Summary: The Goods and Services Tax (GST) in India is undergoing significant reforms, moving from a four-rate structure to a simplified two-rate system. This change is part of a series of reforms announced by the government. The new structure will feature a 5% rate for essential goods and an 18% rate, with a demerit rate of 40% for specific sin and ultra-luxury items. This rate rationalization, impacting over 396 items, aims to lower household expenses and stimulate consumption, particularly among the middle class. The reforms are projected to lead to a revenue loss of approximately Rs.1.48 Lakh Crores, with the effective tax rate expected to decrease to around 9.5% from the initial 14.4% at GST’s introduction. Key changes include reduced rates for passenger vehicles and certain consumer electronics, while taxes on admissions to casinos and race clubs will increase to 40%. The compensation cess has been discontinued, capping the GST rate at 40%.

At the outset:

• 8 years since GST was introduced, the law has been subjected to various changes emanating from tax payer needs and regulatory visions. Now in this 9th year, in line PM Modi’s announcement of ‘3 tier GST reforms’ from the ramparts of Red Fort, sweeping reforms have been recommended by the GST Council wherein a four-rate (5,12,18,28) structure has now been turned into a broad two rate structure (5 & 18) with a merit rate of 5% for essential goods and demerit rate of 40% for sin goods and ultra luxury goods and services. This aligns the rate structure as best suited to economy of India and in line with internationally recognized VAT/ GST models. This is in addition to procedural simplifications and trade facilitations. Though under pipeline for more than a year, GST reforms could not have been recommended at a better time when the geopolitical uncertainties around the world are testing the resolve of the Government of India to ensure policy stability.
• To propel the demand amongst the sub-middle and middle classes, Government of India has already once reduced the tax burden through significantly slashed income tax slab rates. GST reforms would further augment the disposable income in the hands of consumers. Together, these relaxations are among the strongest fiscal levers available to stimulate consumption. In combination total revenue of almost Rs. 1.48 Lakh Crores is estimated to be forgone consequent to such measures. In our opinion, it would not be imprudent to expect that the benefits should offset the costs. The cumulative impact of such continuous reforms can be understood through the fact that the effective rate of tax is now ~9.5% as compared to ~14.4% at the introduction of GST.
• While rate changes are directly visible and are much to be appreciated, important recommendations have been towards trade facilitations, onboarding and compliances simplification, improved procedures for refunds including that to businesses exposed to tax inversions. With GST Appellate Tribunal now a near reality, the framework of GST regime is expected to be further strengthened which will in turn help improve the tax payer’s trust and position India as a country with stable and tested tax policy. This should be further improved by GST Council’s recommendation to induce AI based analytics for sanctioning of provisional refunds and risk evaluation.
• Doing away with the compensation cess, GST is now slated to be capped at 40% rate on any goods or services. This is significantly reduced from earlier combined rates of 50% (SUVs), 48% (Other than SUVs and sub-4 meters vehicles) or 43% (for other vehicles). Accordingly a visible benefit via cost reduction of 3% to 10% is perceived for buyers of goods especially that of new cars. However, it remains to be seen how the car OEMs and dealers would strategize to absorb the cost of accumulated cess (estimated to be ~Rs. 2500 Crores) that shall lapse on midnight of 21st September unless a special transition scheme is carved out — which appears unlikely at this stage. Further, considering National Anti-Profiteering Authority from April 2025 shall not accept any request for examination of anti-profiteering, it would be important to see how the benefits of low rates shall be passed on to consumers after considering the cost of such accumulated cess. In words of Union Minister of Commerce and Industry Shri Piyush Goyal, he has obtained assurance from industry players that benefit shall be passed on to consumers completely. For sin goods (those goods that harm human health or are perceived to be unfit under moral prism) the cess withdrawal shall happen at a later date but anyway in our opinion it is not too far. Transition from old rates to new rates would have to be cautiously addressed including applicability of rates on supplies made on or around the 22nd September, reversal of ITC on newly exempted stock, review of long period contracts and revisit of classification of goods or services.

Overview of recommended rate changes

• More than 430 tariffs of goods or services have been recommended for rate rationalization, of which 396 items are proposed with rate reductions. Goods/ services of merit and essential in nature have almost in each case (~252 items) slashed to 5%/ NIL rates and affects industries all across viz. agriculture, agricultural automotive and machinery, fertilizers, pharmaceuticals and APIs, healthcare including individual life insurance and personal care, textiles & education, thus highlighting the underlying theme of lowering household expenditure and supporting rural growth. A spillover reducing effect of such changes coupled with rate rationalization in case of automobiles, in our opinion, would be felt in logistics sector.
• Aspirational goods especially passenger vehicles (entry and mid-range) are recommended with significant reductions in GST levy with sub 4 meter and <1200 cc (petrol) / 1500 cc (diesel) may see an almost 13% reduction in the total levy. Other segments of PVs such as sub-SUVs and SUVs would see significant reduction as well. Contrary to media reports, GST levy on EV cars has been retained at 5%. Motor vehicles having less than 350cc are recommended to be taxed 18% from existing combined rate of 31% while those above to be taxed at 40% up from existing 31%.
• Consumer electronics such as air conditioners, televisions and dish washing machines which are increasingly seen as necessary purchases almost all middle class households are recommended to be taxed at 18% from earlier 28%. This move in our opinion should propel desired growth in consumption significantly.
• GST levy on cement has been cut to 18% from existing 28%. Job working services are to be taxed at 18% as compared to earlier 12%.
• Admission to casinos, race clubs, sporting events like IPL tickets and etc. are recommended to be taxed at 40% instead of current 28%.

Important considerations on account of rate changes:

• Supplies made shall be levied on either old rate or new rate depending on whether two of the three events- [1] taxable event, [2] invoice date and [3] date of payment- take place before or after the rate change, respectively.
• ITC on procurement of goods now being exempted shall be subjected to proportionate reversal in terms of Section 18(4) and ITC if any thereafter shall lapse.
• It will be important to revisit product classifications and review existing commercial agreements/contracts to ensure that potential exposures are mitigated and the impact of rate changes is properly captured.
• Though not subject to examination, as a measure of trust put in on tax payers, anti-profiteering policies based on sound workable logics should be robustly documented including the computation of benefits that may be passed on to final consumers.
• System level adjustments must be carried out to ensure correct documentation.

Trade Facilitation Measures:

• Supplies made shall be levied on either old rate or new rate depending on whether two of the three events- [1] taxable event, [2] invoice date and [3] date of payment- take place before or after the rate change, respectively.
• ITC on procurement of goods now being exempted shall be subjected to proportionate reversal in terms of Section 18(4) and balance ITC if any thereafter shall lapse.
• It will be important to revisit product classifications and review existing commercial agreements/contracts to ensure that potential exposures are mitigated and the impact of rate changes is properly captured.
• Though not subject to examination, as a measure of trust put in on tax payers, anti-profiteering policies based on sound workable logics should be robustly documented including the computation of benefits that may be passed on to final consumers.
• System level adjustments must be carried out to ensure correct documentation.

Together, these measures reflect the GST Council’s clear focus on reducing friction in compliance and strengthening the GST framework as a business-friendly, trust-based tax regime aimed at enhancing ease of doing business.

It is important to note that currently such changes have been recommended and no accompanying notification or circulars have been issued. This analysis is based on the press release dt. 03^rd Sep 2025 along with the FAQs. Any business decision therefore should be made through in consultation with expert once the amendments in line with the recommendations are actually carried out.