The Compensation Cess Mess: GST 2.0’s Credit Crisis

CA Shiva Goyal & CA Vikash Kumar Banka

 Abstract

The 56th GST Council meeting held on September 3-4, 2025, in New Delhi marked a watershed moment in India’s indirect tax history. Under the chairpersonship of Honorable Union Finance Minister Nirmala Sitharaman, the council announced sweeping reforms that fundamentally restructured the GST framework, transitioning from a complex four-tier system to a simplified two-slab structure. However, the treatment of compensation cess, particularly its subsumption into GST rates and the handling of existing credits, has created unprecedented challenges for businesses across sectors. This article provides a comprehensive analysis of the compensation cess intricacies arising from these historic reforms, examining their legal, constitutional, and practical implications.

1. Introduction: The Dawn of GST 2.0 and the Compensation Cess Conundrum

The 56th GST Council meeting delivered on Prime Minister Narendra Modi’s Independence Day promise of “next-generation GST reforms,” fundamentally altering India’s indirect tax landscape. The transition from the existing four-tier structure (5%, 12%, 18%, and 28%) to a simplified system with merit rate (5%), standard rate (18%), and de-merit rate (40%) represents the most significant tax reform since GST’s inception in 2017.

1.1 The Core Challenge: Compensation Cess Subsumption

The decision to subsume compensation cess into GST rates has created a complex web of issues that threaten to undermine the very benefits these reforms aim to deliver.

The automotive sector exemplifies this challenge most starkly. Previously, vehicles were subject to 28% GST plus compensation cess ranging from 1% to 22%, resulting in effective rates of 29% to 50%. Under the new structure, small cars now attract 18% GST, while larger vehicles and SUVs face 40% GST without separate cess. This transition has created a ₹2,500 crore dilemma for automobile dealers who hold substantial compensation cess credits that may become stranded.

1.2 The FADA Representation: A Microcosm of Industry-Wide Concerns

The Federation of Automobile Dealers Associations (FADA) has quantified the potential losses at ₹2,500 crore, representing approximately 55 days’ worth of vehicle inventory held by dealers across India. This figure, while specific to the automotive sector, illustrates a broader challenge facing multiple industries where compensation cess was previously levied.

FADA President CS Vigneshwar’s statement captures the urgency: “One area that may needs earliest clarification is about levy and treatment of cess balances currently lying in dealers’ books, so that there is no ambiguity during transition.” This concern extends beyond automotive to coal, tobacco, and other sectors where compensation cess formed a significant component of the tax structure.

Sources: (https://economictimes.indiatimes.com/)

2. Rate Structure Analysis: Current versus Proposed Framework

2.1 Motor Vehicles: The Epicenter of Change

The automotive sector has witnessed the most dramatic transformation in the compensation cess regime:

Pre-Reform Structure:

• Small Cars (Petrol ≤1200cc, Diesel ≤1500cc, Length ≤4000mm): 28% GST + 1% cess = 29%
• Mid-size Cars: 28% GST + 17% cess = 45%
• Large Cars and SUVs: 28% GST + 22% cess = 50%
• Electric Vehicles: 5% GST (no cess)

Post-Reform Structure (Effective September 22, 2025):

• Small Cars: 18% GST (10 percentage point reduction)
• Large Cars and SUVs: 40% GST (effective reduction of 5-10 percentage points)
• Electric Vehicles: 5% GST (unchanged)

This restructuring eliminates the complexity of calculating separate cess components while maintaining revenue neutrality for the government. However, it creates significant transitional challenges for businesses with existing cess credits.

2.2 Coal Sector: From Dual Levy to Unified Rate

Coal attracted, prior to rate rationalization, 5% GST+ Compensation Cess of Rs 400/ton. The Council has recommended to end Compensation Cess and hence the rate has been merged with GST. There is no additional burden.

The coal sector’s transformation from a dual-levy system (5% GST + ₹400 per ton cess) to a unified GST rate exemplifies the government’s approach to cess subsumption. Although this measure upholds the principle of revenue neutrality, coal merchants, industries utilizing coal as raw material or fuel, and power companies holding significant cess credits are confronted with uncertainty regarding the admissibility and utilization of such credits. It is also pertinent to highlight that power generation companies are not entitled to avail input tax credit in any form in respect of the generation of electricity.

2.3 Three-Case Coal Scenarios: Detailed Analysis & Impact

2.3.1 Scenario 1: Coal Supply to Power Companies (No ITC Available)

Case Analysis Table

Coal Price	Old Regime (Till Sept 21, 2025)	New Regime (From Sept 22, 2025)	Impact	Winner/Loser
Case 1: ₹2,000/MT	GST 5% = ₹100 + Cess = ₹400 = ₹500 Total	GST 18% = ₹360 = ₹360 Total	New Regime Beneficial by ₹140	Power Company Benefits
Case 2: ₹5,000/MT	GST 5% = ₹250 + Cess = ₹400 = ₹650 Total	GST 18% = ₹900 = ₹900 Total	Old Regime Beneficial by ₹250	Power Company Loses
Case 3: ₹3,080/MT	GST 5% = ₹154 + Cess = ₹400 = ₹554 Total	GST 18% = ₹554 = ₹554 Total	No Impact	No Gain No Loss

Scenario 1: Coal Supply to Power Companies – The Pricing Paradox

The transformation of coal taxation from a dual-levy system to a unified GST rate creates a peculiar situation where the financial impact on power companies depends entirely on the underlying coal price, leading to perverse commercial incentives that will disrupt normal market operations.

2.3.1.1 Case 1: Low-Value Coal at ₹2,000 per MT – Power Companies Benefit

When coal is priced at ₹2,000 per metric ton, the old regime imposed a total tax burden of ₹500 per MT, comprising ₹100 GST (5%) and ₹400 compensation cess. Under the new regime, the same coal attracts ₹360 GST (18%), representing a net saving of ₹140 per MT for power companies. This creates a clear incentive for power companies to delay low-value coal purchases until after September 22, 2025, to capture this cost advantage.

The behavioral implications are significant. Power companies, being cost-conscious entities operating in a regulated environment where fuel costs directly impact tariffs, will naturally optimize their procurement timing to maximize these savings. For a typical power plant consuming 10,000 MT monthly, this translates to ₹14 lakh in monthly savings, making the timing of procurement a critical commercial decision rather than an operational necessity.

2.3.1.2 Case 2: High-Value Coal at ₹5,000 per MT – Power Companies Penalized

Conversely, when coal is priced at ₹5,000 per MT, the old regime’s total tax burden was ₹650 per MT (₹250 GST plus ₹400 cess), while the new regime imposes ₹900 GST (18%). This creates an additional cost burden of ₹250 per MT for power companies purchasing high-value coal post-September 22, 2025. The same power plant consuming 10,000 MT monthly would face an additional cost of ₹25 lakh monthly, creating a strong incentive to advance high-value coal purchases before the transition date.

This price-based differential treatment creates artificial market distortions where procurement decisions are driven by tax implications rather than operational requirements or market conditions. Power companies will rush to execute high-value coal contracts before September 22, while simultaneously delaying low-value coal purchases, creating artificial demand spikes and shortages that have nothing to do with actual energy requirements.

2.3.1.3 Commercial Dispute Genesis

The pricing paradox inevitably leads to commercial disputes because existing supply contracts typically do not account for such dramatic changes in tax treatment. Long-term coal supply agreements, often spanning multiple years, include tax clauses that generally state “taxes as applicable shall be borne by the buyer.” However, these clauses were drafted assuming gradual, predictable changes in tax rates, not fundamental restructuring that creates winners and losers based on arbitrary price thresholds.

Coal suppliers, facing the prospect of losing ₹400 per MT in compensation cess credits that they can no longer utilize, will seek to renegotiate contract terms or demand price adjustments to compensate for their losses. Power companies, particularly those benefiting from lower taxes on low-value coal, will resist such renegotiations, arguing that the contract clearly places tax burden on the buyer. This fundamental disagreement over who bears the transition cost will inevitably result in commercial arbitration and litigation.

2.3.2 Scenario 2: Coal Supply to Manufacturers (ITC Available other than compensation Cess)

Impact Analysis Table

Coal Price	Manufacturer Impact	Coal Trader Impact	Behavioral Change
Case 1: ₹2,000/MT	Old: ₹100 ITC + ₹400 Cost = Net ₹400 Cost New: ₹360 ITC = Net ₹0 Cost Saves ₹400/MT	Old: Can utilize cess credits New: ₹400/MT cess becomes dead cost Loses ₹400/MT	Manufacturers delay orders post-Sept 22
Case 2: ₹5,000/MT	Old: ₹250 ITC + ₹400 Cost = Net ₹400 Cost New: ₹900 ITC = Net ₹0 Cost Saves ₹400/MT	Old: Can utilize cess credits New: ₹400/MT cess becomes dead cost Loses ₹400/MT	Manufacturers delay orders post-Sept 22

Scenario 2: Coal Supply to Manufacturing Companies – The Credit Utilization Dilemma

Manufacturing companies that consume coal as an input face a fundamentally different challenge compared to power companies because they can claim input tax credit on their coal purchases. However, the compensation cess component has always been a dead cost for manufacturers since cess credits could only be utilized against cess liabilities, which most manufacturers do not have on their output supplies.

2.3.2.1 Universal Benefit for Manufacturers Regardless of Coal Price

Under both Case 1 (₹2,000 per MT) and Case 2 (₹5,000 per MT), manufacturing companies experience identical benefits of ₹400 per MT because the cess component, which was previously a dead cost, gets eliminated entirely. In the old regime, manufacturers could claim GST input credit but had to absorb the ₹400 per MT cess as a cost. Under the new regime, the entire 18% GST becomes claimable as input credit, effectively reducing their net coal cost by ₹400 per MT regardless of the underlying coal price.

This creates a powerful incentive for manufacturing companies to delay all coal purchases until after September 22, 2025, to capture this cost advantage. Unlike power companies where the benefit varies by coal price, manufacturers have a consistent ₹400 per MT incentive to postpone procurement across all price ranges.

2.3.2.2 Transfer of Burden to Coal Traders

The elimination of cess benefits for manufacturers directly translates into losses for coal traders. Previously, coal traders could accumulate cess credits and utilize them against their cess liabilities or claim refunds in case of exports. Post-September 22, these accumulated cess credits become stranded assets with no utilization avenue, effectively becoming a ₹400 per MT cost burden for traders.

Coal traders, recognizing this impending loss, face a strategic dilemma. They can either liquidate their existing inventory before September 22 at current prices (accepting normal margins) or hold inventory and face the ₹400 per MT loss when selling to manufacturers post-transition. Rational traders will attempt to clear inventory before the transition date, potentially creating artificial price volatility and supply shortages.

2.3.2.3 Negotiation Dynamics and Market Power

The knowledge that manufacturers will save ₹400 per MT post-September 22 creates a negotiation dynamic where manufacturers will demand price reductions equivalent to their cost savings. Manufacturers, armed with the certainty of ₹400 per MT savings, will argue that coal traders should absorb this amount as a cost reduction rather than treating it as a dead loss. Coal traders, facing the reality of stranded cess credits, may be forced to accept such price reductions to maintain market share and customer relationships.

This negotiation dynamic will vary based on market concentration and relative bargaining power. Large steel companies with significant coal consumption may successfully negotiate price reductions, while smaller manufacturers with limited volumes may face resistance from coal traders. The result will be differentiated pricing based on buyer power rather than uniform market pricing, creating market inefficiencies and potential disputes.

2.3.3 Scenario 3: Coal Export by traders

Impact Analysis Table

Case	Exporter Impact	Importer Impact	Behavioural Change
Case 1: ₹5,000/MT (Normal scenario i.e. before 22nd September)	Total GST including cess: ₹650, refundable under Section 54 (as shown in Scenario 2 above). Exporter receives the entire GST refund; hence, no financial impact.	No impact on the importing country, as the exporter of India secures a full refund of GST.	No significant behavioural change expected.
Case 2: ₹5,000/MT (Coal procured before 22nd September and exported after 22nd September)	GST @ 5%: ₹250, refundable under Section 54. However, cess paid before 22nd September—or payable due to Section 18(4)—becomes a cost element. May result in disputes if purchase orders were placed prior to 22nd September without factoring in cess.	Importers will not bear the cost of cess, increasing the landed price of coal in the hand of Exporter	Importers may insist on sourcing coal procured after 22nd September (with only 18% GST) to avoid the cess burden on earlier procurements.

Export transactions represent the most legally complex and financially damaging aspect of the compensation cess transition due to the mandatory application of Section 18(4) of the CGST Act. The provision creates an inescapable legal trap where exporters face guaranteed losses purely due to the timing of their transactions relative to the policy change.

2.3.3.1 Pre-Transition Export Benefits

Before September 22, 2025, coal exporters enjoyed a favorable tax treatment where both GST and compensation cess paid on inputs were eligible for full refund upon export. For Case 1 coal at ₹5,000 per MT, exporters could claim refunds of ₹650 per MT (₹250 GST plus ₹400 cess), while for Case 2 coal at ₹5,000 per MT, the refund amount was ₹250 per MT (₹250 GST and Cess will not be refunded due to reversal of the same by virtue of implication section 18(4) of the CGST Act).

The refund system worked efficiently because it recognized that exports do not consume domestic resources and should not bear any tax burden. Coal exporters could price their products competitively in international markets, knowing that their input taxes would be fully refunded, creating a level playing field with countries that do not tax exports.

2.3.3.2 Legal Certainty and Absence of Discretion

The application of Section 18(4) is not discretionary or subject to interpretation. The provision uses the mandatory term “shall,” creating a legal obligation that tax authorities cannot waive and taxpayers cannot avoid. Rule 44 of the CGST Rules provides the mechanical calculation methodology, leaving no room for subjective assessment or sympathetic application based on transitional circumstances.

This legal certainty creates a harsh outcome where exporters face guaranteed losses purely due to a government policy change rather than any commercial decision or market failure on their part. The provision applies retrospectively to credits that were legitimately accumulated under the previous regime, creating a situation where past compliance becomes the basis for future penalty.

2.3.3.3 Export Competitiveness Impact

The ₹400 per MT loss imposed by Section 18(4) directly impacts the competitiveness of Indian coal exports. In international commodity markets where margins are often measured in single-digit percentages, a ₹400 per MT disadvantage can make Indian coal uncompetitive compared to suppliers from countries with more favorable tax treatment of exports.

Coal exporters, recognizing this impending disadvantage, will be forced to either accept reduced margins (impacting their business viability) or increase export prices (potentially losing market share to international competitors). Either outcome negatively impacts India’s position in global coal markets and contradicts the government’s broader export promotion objectives.

2.4 Timeline-Based Behavioral Predictions

Period	Power Companies	Manufacturers	Exporters	Market Effect
Till Sept 21, 2025	Rush orders for high-value coal	Normal procurement	Accelerate exports of old stock	Artificial demand surge
Sept 22, 2025 onwards	Avoid high-value coal orders	Demand price cuts from traders	Face ₹400/MT loss on old stock	Supply shortage + price disputes

3. Section 18(4) Applicability: The Legal Framework for Credit Reversal

3.1 Statutory Provision Analysis

3.1.1 The Goods and Services Tax (Compensation To States) Act, 2017

Section 11. Other provisions relating to cess.

(1) The provisions of the Central Goods and Services Tax Act, and the rules made there under, including those relating to assessment, input tax credit, non-levy, short-levy, interest, appeals, offences and penalties, shall, as far as may be, mutatis mutandis, apply, in relation to the levy and collection of the cess leviable under section 8 on the intra-State supply of goods and services, as they apply in relation to the levy and collection of central tax on such intra-State supplies under the said Act or the rules made there under. (Emphasis Supplied)

(2) The provisions of the Integrated Goods and Services Tax Act, and the rules made there under, including those relating to assessment, input tax credit, non-levy, short-levy, interest, appeals, offences and penalties, shall, mutatis mutandis, apply in relation to the levy and collection of the cess leviable under section 8 on the inter-State supply of goods and services, as they apply in relation to the levy and collection of integrated tax on such inter-State supplies under the said Act or the rules made there under:

Provided that the input tax credit in respect of cess on supply of goods and services leviable under section 8, shall be utilised only towards payment of said cess on supply of goods and services leviable under the said section

3.1.2 The Central Goods and Services Tax Act and Rules, 2017

Sec 2(47): “exempt supply” means supply of any goods or services or both which attracts nil rate of tax or which may be wholly exempt from tax under section 11, or under section 6 of the Integrated Goods and Services Tax Act, and includes non-taxable supply;

Sec 2(78): “non-taxable supply” means a supply of goods or services or both which is not leviable to tax under this Act or under the Integrated Goods and Services Tax Act

Section 18(4) of the CGST Act, 2017, mandates credit reversal when a registered person opts for composition scheme or when supplies become wholly exempt. The provision states:

“Where any registered person who has availed of input tax credit opts to pay tax under section 10 or, where the goods or services or both supplied by him become wholly exempt, he shall pay an amount, by way of debit in the electronic credit ledger or electronic cash ledger, equivalent to the credit of input tax in respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock and on capital goods…”

Rule 44. Manner of reversal of credit under special circumstances. –

(1) The amount of input tax credit relating to inputs held in stock, inputs contained in semi-finished and finished goods held in stock, and capital goods held in stock shall, for the purposes of sub-section (4) of section 18 or sub-section (5) of section 29, be determined in the following manner, namely,-

(a) for inputs held in stock and inputs contained in semi-finished and finished goods held in stock, the input tax credit shall be calculated proportionately on the basis of the corresponding invoices on which credit had been availed by the registered taxable person on such inputs;

(b) …..

[(2) The amount, as specified in sub-rule (1) shall be determined separately for input tax credit of central tax, State tax, Union territory tax and integrated tax.

(3) Where the tax invoices related to the inputs held in stock are not available, the registered person shall estimate the amount under sub-rule (1) based on the prevailing market price of the goods on the effective date of the occurrence of any of the events specified in sub-section (4) of section 18 or, as the case may be, sub- section (5) of section 29.]

(4) The amount determined under sub-rule (1) shall form part of the output tax liability of the registered person and the details of the amount shall be furnished in FORM GST ITC-03, where such amount relates to any event specified in sub-section (4) of section 18 and in FORM GSTR-10, where such amount relates to the cancellation of registration.

(5) The details furnished in accordance with sub-rule (3) shall be duly certified by a practicing-chartered accountant or cost accountant.

(6) ……..

3.1.3 Section 18(4): Comprehensive Legal Analysis and Mandatory Application

Understanding the Legal Framework

The provision operates on the fundamental principle that when the nature of supply changes from taxable to exempt, the accumulated credits related to such supplies must be surrendered back to the government. This mechanism prevents taxpayers from enjoying the benefit of input tax credits when their output supplies do not generate corresponding tax liability.

3.1.3.1 Statutory Language and Its Implications

The provision uses the word “shall pay,” which in legal terminology creates a mandatory obligation without any discretionary element. Unlike provisions that use terms like “may” or “can,” the use of “shall” makes compliance non-negotiable. When a registered person’s supplies become “wholly exempt,” the law automatically triggers the reversal mechanism. The term “wholly exempt” has been judicially interpreted to include zero-rated supplies such as exports, making the export scenario particularly vulnerable to this provision.

3.1.3.2 Application to Compensation Cess Credits

In the context of compensation cess subsumption, Section 18(4) creates a unique legal trap. Before September 22, 2025, compensation cess credits accumulated on inputs were eligible for refund when goods were exported. However, post-subsumption, since cess is merged with GST and exports become zero-rated under the new regime, the accumulated cess credits on inventory fall squarely within the scope of Section 18(4). The law does not distinguish between different types of credits – whether GST or cess by virtue of section 11 of The Goods and Services Tax (Compensation To States) Act, 2017 – when applying the reversal requirement.

3.1.3.3 Rule 44: The Mechanical Calculation Process

Rule 44 of the CGST Rules provides the exact methodology for calculating the reversal amount, leaving no room for interpretation or discretion. For inputs held in stock, the calculation is proportionate based on corresponding invoices. For the coal export scenario, if a trader holds 1,000 MT of coal with ₹400 per MT cess credits totaling ₹4,00,000, and exports this stock post-September 22, 2025, the entire ₹4,00,000 must be reversed mechanically. The rule mandates that this amount be debited from the electronic credit ledger, and if insufficient credit balance exists, cash payment becomes mandatory.

3.1.3.4 No Grandfathering Protection

Unlike many transitional provisions in tax law that protect pre-existing rights, Section 18(4) offers no grandfathering protection for accumulated credits. The provision applies based on the current nature of supply, not the historical circumstances under which credits were accumulated. This creates a retrospective impact where credits legitimately accumulated under one regime become subject to reversal under the new regime, purely due to the change in law rather than any fault of the taxpayer.

3.1.3.5 Government’s Intervention Imperative

The harsh and mechanical application of Section 18(4) to compensation cess credits necessitates immediate government intervention through legislative amendment, executive notification, or policy clarification. Without such intervention, the provision will create artificial business losses estimated at thousands of crores across various sectors. The government’s intent behind cess subsumption was simplification and ease of compliance, but Section 18(4)’s automatic application defeats this purpose by creating transitional hardships that could have been avoided through proper grandfathering provisions.

The legal certainty of Section 18(4) application makes it imperative for the government to act swiftly to prevent widespread business disruption during the crucial festive season period when economic activity traditionally peaks.

4. Constitutional Dimensions: Article 300A and Property Rights

4.1 ITC as Constitutional Property

“No person shall be deprived of his property save by authority of law.” — As per Article 300A of the Constitution.

This principle, established through various Supreme Court judgments including Eicher Motors Ltd. v. Union of India and Collector v. Dai Ichi Karkaria Ltd., provides constitutional protection to accumulated compensation cess credits.

4.2 Article 300A Protection Framework

Article 300A states: “No person shall be deprived of his property save by authority of law.” Applied to compensation cess credits, this constitutional guarantee suggests that:

• Arbitrary Denial is Unconstitutional: Any retrospective cancellation or denial of legitimately accumulated cess credits would violate Article 300A.
• Due Process Requirements: Any legislative change affecting existing credits must follow proper constitutional procedures.
• Proportionality Principle: Restrictions on credit utilization must be reasonable and serve legitimate government interests.

4.3 Judicial Precedents Supporting Credit Protection

Key Supreme Court decisions supporting ITC protection include:

• Eicher Motors Ltd. v. Union of India (1999) [taxmann.com 1769 (SC)/[1999] 106 ELT 3 (SC)[28-01-1999]: Established that validly taken Modvat credit is a vested right.
• Union of  India vs. Filco Trade Centre (P.) Ltd. [2019] 104 taxmann.com 187 (SC)[02-01-2019]: Recognized transitional credits as vested rights requiring constitutional protection.
• Siddharth Enterprises  vs. Nodal Officer [2019] 109 taxmann.com 62 (Gujarat)/[2019] 29 GSTL 664 (Gujarat)[06-09-2019]. : Article 300A provides that no person shall be deprived of property saved by authority of law. While right to the property is no longer a fundamental right but it is still a constitutional right. CENVAT credit earned under the erstwhile Central Excise Law is the property of the writ-applicants and it cannot be appropriated for merely failing to file a declaration in the absence of Law in this respect. It could have been appropriated by the Government by providing for the same in the CGST Act but it cannot be taken away by virtue of merely framing Rules in this regard. [Para 42]

4.4 Government’s FAQ Response and Constitutional Analysis

Frequently Asked Questions (FAQs) on the decisions of the 56th GST Council held in New Delhi

Posted On: 03 SEP 2025 11:28PM by PIB Delhi

(https://www.pib.gov.in/PressReleasePage.aspx?PRID=2163560)

Question No. 38 Why is 40% rate referred to as a ‘special rate’? What is the basis for subjecting goods to special rate?

Answer: The special rate is applicable only on few select goods, predominantly on sin goods and few luxury goods and therefore is a special rate. Most of these goods attracted Compensation Cess in addition to GST. Since it has been decided to end the Compensation Cess levy, the Compensation Cess rate is being merged with GST so as to maintain tax incidence on most goods. On other goods and services, the special rate has been applied as these were already attracting the highest GST rate of 28%.

Question No. 48: Why has GST rate on coal been increased? Will this not impact electricity cost?

Answer: Coal attracted, prior to rate rationalization, 5% GST+ Compensation Cess of Rs 400/ton. The Council has recommended to end Compensation Cess and hence the rate has been merged with GST. There is no additional burden.

As per the published FAQs, it is noted that the compensation cess has been subsumed into GST. In this context, a pertinent question arises under Article 300A of the Constitution as to why the benefit of such subsumption may not extend to the industry. While the FAQs acknowledge the fact of cess subsumption, they do not explicitly address the constitutional implications for holders of existing credits. This leaves open the possibility of a constitutional consideration, wherein businesses may advance the view that the benefit of cess subsumption ought to flow to them as legitimate credit holders.

5. Transitional Provisions: Bridging the Gap

5.1 Lessons from 2017 GST Implementation

The GST implementation in 2017 provides valuable precedents for managing transitional challenges. Section 140 of the CGST Act allowed carry-forward of pre-GST credits, establishing the principle that legitimate credits should not be lost during structural reforms.

5.2 Current Transitional Framework Gaps

Unlike the comprehensive transitional provisions of 2017, the 56th GST Council’s decisions lack specific mechanisms for handling existing compensation cess credits. This gap has created uncertainty across industries, with businesses unsure about:

• Credit utilization timelines
• Conversion mechanisms
• Refund possibilities
• Reversal requirements

5.3 International Best Practices

Global VAT/GST systems typically provide robust transitional arrangements during structural reforms. The European Union’s VAT system, Canada’s GST, and Australia’s GST all incorporate mechanisms to protect legitimate credits during system changes, ensuring business continuity and preventing artificial losses.

6. Industry-Specific Impact Analysis

6.1 Automotive Sector: The Epicenter of Disruption

The automotive industry faces the most severe impact from cess subsumption:

Dealer Inventory Challenge: With 55 days of inventory typically held by dealers, the ₹2,500 crore figure represents immediate cash flow implications. Dealers who purchased vehicles under the old regime (28% GST + cess) but must sell under the new regime (18% for small cars, 40% for large cars) face potential credit stranding.

Supply Chain Disruption: The mismatch between input credits (based on old rates) and output liabilities (based on new rates) creates working capital challenges throughout the automotive supply chain.

Festive Season Impact: The September 22, 2025, implementation date coincides with India’s crucial festive season, traditionally the peak period for automobile sales. Any uncertainty in credit utilization could dampen consumer demand during this critical period.

6.2 Coal and Power Sector

The coal sector’s transition from ₹400 per ton cess to unified GST rates affects:

Coal Merchants: Accumulated cess credits from coal purchases may become unutilizable against unified GST liabilities.

Power Companies: Large coal consumers holding substantial cess credits face uncertainty about credit recovery.

Mining Companies: Coal producers must navigate the transition while maintaining compliance across multiple state jurisdictions.

6.3 Manufacturing Sectors

Industries using coal, automobiles, or other cess-attracting inputs as raw materials face cascading effects:

Steel Industry: Dependent on coal inputs, faces potential credit disruption.

Cement Sector: Significant coal consumption creates exposure to cess credit challenges.

Chemical Industry: Uses automotive and coal inputs, creating multi-layered credit complications.

7. Proposed Solutions and Recommendations

7.1 Extended Utilization Framework

Timeline Extension: Provide businesses with an extended period (until March 31st, 2026) to utilize existing compensation cess credits against future GST liabilities. This grace period would enable businesses to liquidate existing inventory and adjust their credits without financial distress.

Rationale: This approach recognizes the practical realities of inventory cycles and provides sufficient time for businesses to transition without artificial losses.

7.2 Credit Conversion Mechanism

Automatic Conversion: Implement provisions similar to the 2017 GST transition, permitting automatic conversion of unutilized compensation cess credits to regular GST credits. This would allow utilization against future tax liabilities across all tax heads.

Technical Implementation: Modify GST portal systems to automatically convert cess credits in electronic credit ledgers to regular GST credits, maintaining audit trails and compliance requirements.

7.3 Legislative Refund Provision

Statutory Amendment: Amend relevant GST law provisions to specifically allow refund claims for unutilized compensation cess credits. This provides a safety valve for businesses that cannot adjust credits through normal business operations within the transition period.

Eligibility Criteria: Establish clear criteria for refund eligibility, including documentation requirements, time limits, and verification procedures to prevent fraudulent claims while ensuring legitimate businesses receive relief.

7.4 Sector-Specific Solutions

Automotive Industry:

• Allow dealers to claim refunds for credits attributable to inventory purchased before September 22, 2025
• Permit credit utilization against future GST liabilities beyond direct automotive sales
• Establish fast-track processing for automotive sector refund claims

Coal Sector:

• Convert ₹400 per ton cess credits to equivalent GST credits based on prevailing coal prices
• Allow coal merchants to use converted credits across their entire business portfolio
• Provide special provisions for power companies with large coal credit balances

8. Conclusion: Navigating the New Normal

The 56th GST Council meeting’s decisions represent a paradigm shift toward a simplified, more efficient tax system that promises long-term benefits for India’s economy. However, the immediate challenge of managing compensation cess credit transitions requires urgent, comprehensive, and constitutionally sound solutions.

The ₹2,500 crore automobile sector impact, while significant, represents just the tip of the iceberg. Across industries—from coal and power to manufacturing and services—businesses hold substantial compensation cess credits that need protection and smooth transition mechanisms. The government’s approach to this challenge will determine whether GST 2.0 becomes a catalyst for economic growth or a source of business disruption.

8.1 The Constitutional Imperative

8.2 The Road Ahead

The government must act swiftly to address transitional challenges while maintaining the reform momentum. The proposed solutions—extended utilization periods, automatic credit conversion, and legislative refund provisions—provide a balanced approach that protects business interests while serving government objectives.

The success of GST 2.0 will ultimately be measured not just by its long-term simplification benefits, but by how effectively the government manages the complex transition from the current system. By addressing compensation cess credit concerns promptly and comprehensively, the government can ensure that its ambitious tax reforms deliver on their promise of ease of doing business and economic growth.

The clock is ticking toward September 22, 2025. The decisions made in the coming weeks will determine whether this historic tax reform becomes a model for the world or a cautionary tale about the importance of managing complex transitions. With appropriate safeguards, clear communication, and constitutional compliance, GST 2.0 can fulfill its promise of creating a truly simplified, efficient, and growth-oriented tax system for India.

About the Authors:

• CA Shiva Goyal and CA Vikash Kumar Banka is a distinguished GST expert with extensive experience in indirect taxation and policy analysis.

This article represents the authors’ analysis of publicly available information and legal provisions. Readers should consult qualified professionals for specific compliance guidance.

CA Vikash Kumar Banka

CA Shiva Goyal