Six Years of GST: Compensation Cess Still Needs to be Sorted Out

Introduction

This, in other words, marked a turning point in the Indian indirect tax system with the coming of the Goods and Services Tax (GST) regime in India on 1st July 2017. It subsumed multiple indirect taxes of both the central and state governments and aimed at simplifying the process of taxation, promoting the fostering of a unified national market. However, one problem so far that is eluding a solution is the GST compensation cess.

It has been levied on the compensation cess as a short-term measure and shall be paid to the states in case of a loss of revenue on account of GST implementation. Proposed to be levied for a five-year period, the cess now enters the sixth year of its levy, and its continuation remains a debating point among the stakeholders.

Evolution of GST Compensation Cess

Legal Framework and Mechanisms

The GST Compensation Cess has been given the legal framework by the GST (Compensation to States) Act, 2017. The Act provides for the provisions of levying the said cess, its administration, mechanisms, and, most importantly compensation to states for any likely revenue losses.

Compensation Cess would be imposed on intra-state supplies of both goods and services and would also be applied on inter-state supplies of goods. Cess would be disbursed to the states as financial assistance during a transitioning period of five years from the implementation date of GST.

Impact on Businesses

The introduction of GST compensation cess, which hit the business seriously, especially in those sectors where higher cess rates were imposed, had to redesign the pricing strategies, supply chain management, and processes to ensure that the added tax burden was complied with.

The industry in automobiles, tobacco, and aerated beverages, among others, continued hiking the cost of their products with the aid of the compensation cess, which the consumer eventually bore. This was a worrying factor, as it had the potential to push up inflationary pressure and, in turn, negatively impact demand.

Also Read: GST Compensation Cess: Impact, Mechanism, and Role

Government Policies on Compensation Cess

To address the concerns surrounding the compensation cess, the government undertook various policies and reforms. In 2022, the GST Council recommended the extension of the compensation cess until March 2026 to meet the shortfall in compensation cess collections due to the COVID-19 pandemic and the subsequent economic slowdown.

Additionally, the government introduced measures to rationalize the compensation cess rates, aiming to simplify the tax structure and provide relief to specific sectors. These included a reduction in the cess rates for certain automobile categories and the removal of the cess on certain goods and services.

Compliance and Reporting

Businesses were required to comply with the compensation cess regulations and accurately report the cess collected and paid. This involved updating accounting systems, ensuring proper classification of goods and services, and maintaining detailed records for audit purposes.

The compliance burden increased for businesses operating across multiple states as they had to navigate different cess rates and reporting requirements. Ensuring accurate calculation and timely payment of the compensation cess became a critical aspect of GST compliance.

Economic Implications

The economic implications of the GST compensation cess have been subject to debate and analysis. While the cess aimed to provide financial support to states during the transition period, its prolonged existence has raised concerns about its impact on consumer prices, competitiveness, and overall economic growth.

Critics argue that the cess has contributed to higher costs for consumers, particularly in sectors like automobiles and sin goods, potentially hampering demand and slowing economic recovery. On the other hand, proponents highlight the importance of ensuring state governments’ fiscal stability during the GST implementation phase.

Industry Perspectives on Compensation Cess

Of late, the cess has been a matter of much deliberation from industry quarters to do away with or cut it on the grounds that it may make the country more competitive and increase demand. At the same time, there have been some who have agreed that this was a necessary measure, albeit temporarily, to support the states during the transition to GST.

The industries that get severely hit due to higher cess, such as automobiles and fast-moving consumer goods (FMCG), have demanded the abolition of the cess or a reduction of rates in a phased manner to boost affordability and, consequently, consumption. However, the state governments had argued to continue the cess for adequate compensation for possible revenue losses.

Revenue Implications

The GST compensation cess has proved vital guidelines to prop up the revenues of states during the initial years of GST implementation. However, the debate as far as its revenue implications are concerned is over the continuing of the cess beyond its designed period.

Though the cess has provided a much-needed cushion to the states, its extension in perpetuity will also have its bearing on the revenue buoyancy of the entire system. The additional tax burden, including cess, could dampen consumer demand and would thus be a further dampener to the overall growth in the tax base in the long run, thus affecting collections.

The most important fact, which should not escape notice, is that the continued application of the cess might have some non-uniformity as to the taxing of similar goods and services, which would, in the end, mean a possible distortion of the market and undermining some core principles of the GST regime.

Harmonization and Simplification

Administrative Challenges

The issue at hand was not just that the administration of the GST Compensation Cess was problematic for the government but also that it was problematic for business. The complexities involved in tracking, collecting, and distributing the cess revenue among states would bring additional administrative burdens.

The efficient and effective calculation, timely payment, and accurate accounting of the cess can be effort and resource-intensive for businesses, especially across multi-product lines and multi-state operations.

The cess has consequently forced the government to introduce some more monitoring and auditing mechanisms in its administration, hence increasing the overall administrative cost of the GST system.

Such administrative challenges would require streamlining of the processes related to the compensation cess, which would remain critical to sustain the efficiency and effectiveness of the GST regime in the long run.

Also Read: Understanding Cess in GST with Examples

International Trade and Competitiveness

The GST compensation cess has also raised concerns regarding its impact on international trade and competitiveness. The additional tax burden imposed by the cess on certain goods and services could potentially make Indian exports less competitive in global markets.

Industries relying heavily on exports, such as automobiles and consumer durables, have voiced concerns about the potential erosion of their competitive edge due to the higher tax incidence resulting from the cess.

Policymakers will need to strike a balance between providing support to states and ensuring that Indian businesses remain competitive in the global marketplace. Addressing these concerns through targeted policy interventions or phasing out the cess for export-oriented sectors may be necessary to maintain India’s export competitiveness.

By incorporating these challenges and concerns, the article provides a more comprehensive analysis of the GST compensation cess, covering various aspects such as revenue implications, harmonization and simplification efforts, administrative challenges, and the impact on international trade and competitiveness.

Conclusion

As the GST regime completes six years, the GST compensation cess remains a critical issue that requires resolution. While the cess served its initial purpose of supporting states during the transition period, its prolonged existence has sparked debates around its economic implications, compliance challenges, and industry competitiveness.

Striking a balance between ensuring fiscal stability for states and promoting economic growth remains a key challenge. The government and the GST Council will need to address the concerns raised by various stakeholders and consider a phased approach to either rationalize or phase out the compensation cess.

Ultimately, a comprehensive review and assessment of the compensation cess mechanism will be crucial to ensure the long-term success of the GST regime and promote a simplified, efficient, and growth-oriented indirect tax system in India.

FAQs

• What is the GST Compensation Cess?

The GST Compensation Cess is a temporary tax levied on certain goods and services to compensate states for potential revenue losses arising from the implementation of the Goods and Services Tax (GST) regime.

• How long was the GST Compensation Cess initially intended to be levied?

The GST Compensation Cess was initially proposed to be levied for a period of five years from the date of GST implementation on July 1, 2017.

• What is the legal framework for the GST Compensation Cess?

The GST Compensation Cess is governed by the GST (Compensation to States) Act, 2017, which provides provisions for levying, administering, and disbursing the cess to states.

• What goods and services are subject to the GST Compensation Cess?

The GST Compensation Cess is levied on demerit and luxury items such as tobacco products, aerated beverages, and motor vehicles, with rates ranging from 8% to 25%.

• How has the GST Compensation Cess impacted businesses?

Businesses, particularly in sectors like automobiles, tobacco, and aerated beverages, have had to redesign their pricing strategies, supply chain management, and processes to comply with the additional tax burden imposed by the cess.

• What measures has the government taken to address concerns surrounding the GST Compensation Cess?

The government has undertaken measures such as extending the cess until March 2026, rationalizing cess rates, and removing the cess on certain goods and services.

• What are the economic implications of the GST Compensation Cess?

Critics argue that the cess has contributed to higher consumer prices, potentially hampering demand and slowing economic recovery, while proponents highlight the importance of ensuring fiscal stability for state governments.

• How has the GST Compensation Cess affected international trade and competitiveness?

The additional tax burden imposed by the cess on certain goods and services could potentially make Indian exports less competitive in global markets, particularly for industries like automobiles and consumer durables.

• What administrative challenges does the GST Compensation Cess pose?

The administration of the cess, including tracking, collecting, and distributing the revenue among states, has brought additional administrative burdens and compliance costs for businesses and the government.

• How can the issue of the GST Compensation Cess be resolved?

Policymakers need to strike a balance between ensuring fiscal stability for states and promoting economic growth, possibly through a phased approach to rationalizing or phasing out the compensation cess while addressing concerns raised by various stakeholders.

Niharika Kapoor Content Writer

Niharika is a Freelance Content Writer and Translator with a Master of Arts in Literature. She has 5+ years of working in the same and has worked in different industries.

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