pri 41st GST Council Meeting- Gloomy picture for States 41st GST Council Meeting- Gloomy picture for States


July 1, 2020 marks the three-year anniversary of independent India’s most revolutionary tax reform i.e. Goods and Services Tax. From the midnight of July 1, 2017 Indian market became one unified market with a uniform tax structure across all federal units and August 24, 2020 marks the first death anniversary of the great leader who brought such a ground-breaking tax reform in Indian economy. With the sole motive of bringing ‘ease of doing business norms’ in India, Late Shri Arun Jaitley, made the life of business houses to be less burdened with taxes and tax filing formalities and more focused on innovating through the businesses, thus thriving greater consumer satisfaction.

Goods and Services Tax (GST)

GST subsumed 17 different taxes and 13 cesses which ensured that there were no more queues of trucks and no more state barriers. However, as Arvind Subramanian, professor, Ashoka University, and former Chief Economic Adviser, Government of India, recalls in the Indian Express[1], “as Jaitley’s health and influence declined, the reforms that he spearheaded began to falter”. The 41st GST Council meeting over Video Calling amid this Pandemic is a proof of the statement made above. It is not a hidden fact that pandemic halt has caused an adverse impact on the businesses, due to which they are not able to generate enough revenue. The decline in businesses has in-turn declined the tax collections causing lack of funds with the Government for compensating States/UTs.

41st GST Council meeting was held with the sole object of resolving the issue of lack of funds to compensate the states, which was initially promised to the States at the time of introduction of Goods and Service Tax Act.

One of the major impediments in introduction of GST, as pointed out by former Finance Minister is lack of trust between States and Center. Thus, Jaitely made sure that such trust deficit was abridged. As stated by Arvind Subramanian (Supra)[2], “The best illustration of his role was in 2017 when CPM-run Kerala stood firm but isolated on the issue of gambling taxation. Kerala’s personable and well-intentioned Finance Minister, Thomas Isaac, said he had no choice but to leave the negotiating room, at which point, in a truly Bollywood moment, Jaitley pleaded for him to stay. The strategy worked: Isaac stayed, and Jaitley was able to forge a compromise that met Kerala’s needs, while preserving unity within the Council. If the GST was a tribute to India’s cooperative federalism, Jaitley was its agent and embodiment.” Therefore, States ultimately agreed to give up their right to tax output individually for better unified tax system in lieu of compensation over 5 years. It is for this reason separate GST (Compensation to States) Act, 2017 was enacted. The preamble of the same reads as under

An Act to provide for compensation to the States for the loss of revenue arising on account of implementation of goods and service tax in pursuance of the provisions of the Constitution (One Hundredth and First Amendment) Act, 2016

Thus, Compensation Cess Act, acts as glue between Center and States for GST model that it stands today. However, it has cost attributed to it. For many experts, such cost of compensation was way too much at 14% p.a. as the projected growth rate. The heat of such step to lure the State governments has been felt today amid this pandemic. In the latest GST Council meeting Center positioned its inability to provide for compensation as provided under section 7 (4) of GST (Compensation to States) Act, 2017 and thus this article aims to understand such situation.

Center has provided for two options for such revenue shortfall. The same has been provided below:

The States are given two options:

  • to provide a special borrowing window to states, in consultation with the RBI, to provide Rs 97,000 crore at a “reasonable” interest rate and this money can then be repaid after 5 years by extending cess collection. This amount is, thus limited to the extent of the losses caused due to transition to GST and not the loss due to the Pandemic.
  • to meet the entire GST compensation gap of Rs 2.35 lakh crore this year itself, after consulting with the RBI. This amount includes whole shortfall of GST compensation of 3 lakh crore, thus includes the loss due to pandemic and lockdown.

In addition, the States will also be given a further relaxation in FRBM of 0.5% points for market borrowings if option 1 is opted for. The States were given 7 days’ time to choose from both the options.  Though, the Attorney General of India has given his opinion that it is the duty of Center to provide for compensation needs of the States in the five years of introduction of GST, as stipulated in the section 8 of GST (Compensation to States) Act, 2017. However, even after such opinion, Center has almost shunned its responsibility to provide compensation to the States and has given option to States to borrow from RBI. Therefore, the issue arises as to how to finance the lost compensation to the States. But before that other issue which stands tall in the face of GST council is whether Center is legally responsible for providing compensation amid this pandemic.

Arguments made

It is interesting to note that Finance Minister (FM) has pointed towards the doctrine of Force Majeure i.e. Act of God. “It is an English doctrine that act as a tool to set aside contracts where an unforeseen event either renders contractual obligations impossible, or radically changes the party’s principal purpose for entering into the contract”[3]. In Contracts Act, 1872 such doctrine has been recognized under section 56. The essential idea upon which the doctrine of frustration of contract is based is that of the impossibility of performance of the contract. It is well established in the contract jurisprudence that ‘Impossibility’ under S.56 doesn’t mean literal impossibility to perform (owing to strikes, commercial hardships, etc.) but refers to those cases where a supervening event beyond any foreseeability and control of the parties (like the change of circumstances) destroys the very foundation upon which the contract rests, thereby rendering the contract ‘impracticable’ to perform, and substantially ‘useless’ in view of the object and purpose which the parties intended to achieve through the contract. Going by this, if FM is hinting to use such doctrine, it has to be understood in the first place that Center’s duty to pay compensation is not any contractual obligation, but raison d’etre for States to willingly waive their right to collect their respective indirect taxes and agreed to unified structure of GST. Thus, the situation of pandemic does not destroy the very foundation upon which the contract to compensate the states rests. Such contract exclusively rests upon the promise of Center to pay compensation due to transfer from legacy laws to GST and is clearly not frustrated yet.

Another interesting point to consider is what other options are left with States if compensation is not made to them by the Center. Article 246A of Constitution of India provides for special provision with respect to Goods and Services tax, in which clause 1 held that Legislature of every State, have power to make laws with respect to goods and services tax imposed by the Union or such State. Therefore, it has been an option with the States to charge extra Cess and Surcharge on such good over and above GST. The same must be approved by the GST council. Thus, if States start imposing their portion of tax higher or any additional Cess, it will be the disaster for the tax regime, which is still in its nascent stage. The very idea of GST will be torn down, which however, may be more lucrative step for the States than taking loans which leads to additional burden to their already debt-ridden exchequer. The 7 days are given to ponder about the proposal, however, it is advisable for Center deliberate with States and renegotiate the terms of compensation instead of going back foot on its commitment in the garb of Act of God, because such Act of God has made the need for the compensation more imminent. It is also suggested that Center and states should discuss the already high projected growth rate of 14% p.a. to, may be, a lower growth rate. It has to be noted that the need is from both sides, thus both the sides have to make conscious efforts to come to one amiable agreement.

Another important way forward is to increase the Cess rate on sin goods to increase the funds of revenue kitty. In fact, it has been forefront argument in the recent years to impose more tax on tobacco products. India is signatory to WHO Framework Convention on Tobacco Control which calls for minimum 75% tax burden to minimize the consumption and India has not reached such limit. Thus, increasing Cess on such commodities will help achieve India dual objective of revenue generation and public health improvement. However, a thought needs to be given to current economic scenario. Small businesses and many MSMEs are already at verge of shutting down and are craving for State support. Increasing tax at this moment on tobacco industry which largely operates through small enterprises would further hurt the business sentiment and thus job opportunities. Further, if we look at automobile sector, economic slowdown in last one year and pandemic situation has already broken the spine of this industry. For instance- luxury two wheelers Company, Harley Davidson, is already downsizing its operations in India. Besides that, the need of funds for compensation revolves around three lakh crore, which is completely impossible to be financed solely by these cess hikes on sin goods or luxury goods. Imposing taxes at this stage would mean showing exit to these already semi-broken companies. Thus, any move to increase tax or cess on sin or luxury goods is not viable, be it economically, politically, or practically. Hence, this option needs to be cut down from the list for funds raising option by the States.

This brings us to next important method of financing the States, which has also been recommended by the Center i.e. provision of borrowing at the discounted rates. However, many States has objected to such move stating that provision of compensation is legal as well as moral duty of Center. Therefore, one can argue that it is Center who should raise loan from RBI and provide it to the States and not the other way round as suggested. Here, it is interesting to note that GST (Compensation to States) Act, 2017 prescribes the time limit of 5 years for compensation to States. However, according to section 8(1) of the Act, such levy of tax can be extended further on the recommendations of Council. Thus, it would be practically plausible for Centre to raise such loan in its name and disburse it to the States and later such loan is repaid through Cess levied from sixth year. The reason why Center should come forward over raising loan is multifold. Firstly, GST as law is completely based on trust which has been reposed by the States in the Center. This trust has shaken in recent months and this may be the best time to show that Center stands with the States in its true federal color. Secondly, Center is obviously in better financial position to provide guarantee for such huge amount. Thus, in the spirit of federalism it is recommended that center should come forward and raise the loan to compensate the States, so that it can honor its promise while implementing GST in 2017.


In the end, it shall be seen, which option does States choose or will there be some new way to resolve the issue of Compensation. It is relevant to note that this pandemic situation is once in a century and expect special efforts from both States and Centre. It is the need of the hour that GST Council takes up this issue seriously. Failure of GST would be failure of India as a country capable of any economic reform. Therefore, resolving such crisis would be the best tribute to late former Finance Minister, Mr. Arun Jaitely.

[1] The Indian Express dt. 24.08.2020

[2] Ibid.

[3] Taylor v Caldwell (1863) 3 B & S 826

Neha Jain And Anshul Mittal
Neha Jain, Associate, RSA Legal Solutions Anshul Mittal, Partner, RSA Legal Solutions, LLM (Corporate and Indirect tax laws)

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  1. mittalanshul27 says:

    GST row: 13 states submit options

    At least 13 states have given their borrowing options, proposed by the GST Council, to meet their compensation shortfall and six more states — Goa, Assam, Arunachal Pradesh, Nagaland, Mizoram and Himachal Pradesh — are expected to do so shortly, finance ministry sources said on Sunday.
    The 12 states that preferred the borrowing option 1 are Andhra Pradesh, Bihar, Gujarat, Haryana, Karnataka, Madhya Pradesh, Meghalaya, Sikkim, Tripura, UP, Uttarakhand and Odisha. So far only one state — Manipur — opted for the second option.

    A few states have submitted their views to the chairperson of the GST Council and are yet to decide on the options.


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  3. V K Agarwal says:

    Economic conditions of everyone are difficult & extraordinary in present scenario.Thus, possible course is amicable negotiations. 14% be divided in 3 parts. One part of say 6% for waiver & reduction for future as excess rate of compensation for shortfall. 4% payment in 2 installments in 2020-21, 2%payment in 2021-22 & balance 2% in 2022-23.
    This can be acceptable to all as rate of 14% is too high. a provision can be made for very weaker states needing special requirements, to give additional compensation for shortfall if any in this period of 5 years.Give & take policy should be adopted at negotiations & matter sorted out amicably.

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