Remembering the good old days when we often received pocket money from our parents for funding our expenses, similarly under Goods and Service Tax (‘GST’) law Center apportions a share of its revenue to states for their expenses too.

One such source of revenue under GST is the compensation cess levied on specified luxury items or demerit goods, like Pan Masala, Tobacco, Aerated Waters, Motor Cars, etc. “The Goods and Services tax (Compensation to States) Act, 2017” empowers Government to levy GST compensation cess. Compensation cess is leviable on value of supply as ascertained under section 15 of Central Goods and Services Tax Act, 2017 (‘CGST Act’) both on intra-state as well as inter-state supplies with a view to provide compensation to the states for the loss of revenue arising on account of implementation of GST.

Compensation cess was introduced as relief for States for the loss of revenues arising from the implementation of GST to States, in lieu of giving up their powers to collect taxes on goods and services after local levies were subsumed under the GST for a period of 5 years. For the purpose of calculating the compensation amount, financial year 2015-16 was assumed to be the base year. The growth rate of revenue for a State during the five-year period was assumed at 14 percent a year. Compensation is paid bi-monthly while last installment for any financial year is given in the next year.


Facing a sharp decline in GST collections due COVID-19 lockdown across the country, the government is looking at paying GST compensation to states using a portion of its borrowings and repaying it by collecting cess in the sixth or further subsequent years.

As per the GST Act, full compensation to the states has to be paid for a period of first five years (i.e. till FY 2022) only through the compensation fund that gets its funds through levy of GST compensation cess on few items. However, pursuant to the collections being reduced in the fund, the GST compensation to states has been delayed with Centre. Now Government is looking forward at getting the GST Council’s nod for extending the levy of compensation cess at least a couple of years beyond the fifth year cut-off to make good the gap in cess collection actual compensation payment to states. With economic activity and GDP growth projected to remain subdued for the most part of FY 2020-21, the Centre is also looking at all possible means, how it could meet its constitutional obligation of compensating the states for their revenue loss.

Few options available being are listed below:

  • Either increasing the compensation cess rates;
  • Increasing the cut off time limit of 5 years to couple of years more;
  • Bringing more items under the cess base by expanding the base of GST cess items.

Conclusion: Any policy decision leading to additional hit on the pockets of the taxpayer would be an added burden on them considering the difficult economic scenerio.

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May 2021