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Key Highlights
- GST Compensation Cess was introduced in 2017 to help states recover revenue losses after GST implementation, applying to goods like tobacco, luxury cars, and aerated drinks.
- The cess funds are distributed to states based on a projected 14% annual revenue growth from the 2015-16 base year, covering any revenue shortfall.
- Initially planned for five years until June 2022, the cess has been extended to March 2026 to continue supporting states and repay previous borrowings.
You run a business where your sales are steady, your customers are happy, and everything seems to be on track. Suddenly, a new tax is introduced, and your expenses go up overnight. Your profit margins shrink, and you start wondering how you will manage your finances. Many businesses felt this when GST (goods and services tax) was introduced in India in 2017. To support states that lost revenue due to GST, the government implemented something called the GST Compensation Cess. This guide is for you if you are a business owner or consumer or want to understand this tax better.
What is Cess in GST?
The goods and services tax (Compensation to States) Act of 2017 introduced the GST compensation cess to offset revenue losses incurred by states following the implementation of GST on July 1, 2017. This cess was initially set for five years or any extended period recommended by the GST Council. It applies to specific goods, including tobacco, luxury cars, coal, soft drinks, and pan masala. The revenue generated from this cess is allocated to states to ensure financial stability during the transition to the new tax regime.
List of Goods Covered under Compensation Cess
The GST (Compensation to States) Act, 2017, which is periodically amended, specifies different goods along with their applicable cess rates. The details are as follows:
| Goods | GST Compensation Cess |
| Cut tobacco | ₹0.14/ unit |
| Unmanufactured tobacco (with lime tube) – marketed under a brand name | ₹0.36/unit |
| Unmanufactured tobacco (excluding lime tube) – sold under a brand name | ₹0.36/unit |
| Branded tobacco refuse | ₹0.32/unit |
| Tobacco extracts and essences associated with a specific brand name | ₹0.36/unit |
| Tobacco extracts and essences without a brand name | ₹0.36/unit |
| Filter khaini | ₹0.56 per unit |
| Cheroots and Cigar | 21% or ₹4170/thousand, whichever is higher |
| Jarda scented tobacco | ₹0.56/unit |
| Cigarillos | 21% or ₹4170/thousand, whichever is higher |
| Cigarettes made from tobacco, excluding filter variants, with a length not exceeding 65mm | 5% + ₹2076/thousand |
| Cigarettes made from tobacco, excluding filter cigarettes, with a length exceeding 65mm but not surpassing 75mm | 5% + ₹3668/thousand |
| Filter cigarettes with a total length, including the filter (with the filter measuring either 11 millimetres or its actual length, whichever is greater), must not exceed 65 millimetres | 5% + ₹2076/thousand |
| Filter cigarettes with a total length, including the filter (which must be at least 11 millimetres or its actual length, whichever is greater), measuring more than 65 millimetres but not exceeding 70 millimetres | 5% + ₹2747/thousand |
| Filter cigarettes with a total length, including the filter (which must be at least 11 millimetres or its actual length, whichever is greater), measuring more than 70 millimetres but not exceeding 75 millimetres | 5% + ₹3668/thousand |
| Cigarettes made from tobacco alternatives | ₹4006/thousand |
| Cigarillos made from tobacco alternatives | 12.5% or ₹4,006/thousand, whichever is higher |
| Herbal blends for pipes and cigarettes | 290% |
| Branded tobacco products marketed as ‘hookah’ or ‘gudaku’ | ₹0.36/unit |
| Tobacco used for smoking hookah or chilam, commonly referred to as hookah tobacco or gudaku, without a brand name | ₹0.12/unit |
| Other water pipe smoking tobacco that does not have a brand name | ₹0.08/unit |
| Other branded smoking tobacco | ₹0.28/unit |
| Other types of smoking tobacco without a brand name | ₹0.08/unit |
| Homogenised or reconstituted tobacco with a brand name | ₹0.36/unit |
| Chewing tobacco (excluding lime tube) | ₹0.56/unit |
| Chewing tobacco with a lime tube | ₹0.56/unit |
| Products that include chewing tobacco | ₹0.36/unit |
| Pan masala (gutkha) with tobacco | ₹0.61/unit |
| All goods, except for pan masala that contains tobacco (gutkha), which carry a brand name | ₹0.43/unit |
| All goods, except pan masala containing tobacco (gutkha), that do not have a brand name | ₹0.43/unit |
| Snuff | ₹0.36/unit |
| Preparations that have snuff | ₹0.36/unit |
| Coal, ovoids, briquettes, and other solid fuels produced from lignite or coal, whether agglomerated or not, excluding jet, as well as peat (including peat litter), whether agglomerated or not | ₹400/tonne |
| Aerated waters | 12% |
| Lemonade | 12% |
| Others | 12% |
| Motorcycles with an engine capacity greater than 350cc | 3% |
| Aircraft, including helicopters and other types, intended for personal use | 3% |
| Yachts and other recreational or sporting vessels | 3% |
| Motor vehicles designed to carry a maximum of 13 individuals, including the driver | 15% |
| Motor vehicles, except for ambulances, three-wheelers, and those with an engine capacity of 1500 cc or less and a length of up to 4000 mm, that are powered by both a spark-ignition internal combustion reciprocating piston engine and an electric motor or by both a compression-ignition internal combustion piston engine (diesel or semi-diesel) and an electric motor | 15% |
| Motor vehicles powered by petrol, liquefied petroleum gas (LPG), or compressed natural gas (CNG) with an engine capacity of up to 1200 cc and a maximum length of 4000 mm | 1% |
| Diesel-powered motor vehicles with an engine capacity of up to 1500 cc and a length not exceeding 4000 mm | 3% |
| Motor vehicles with an engine capacity of no more than 1500 cc | 17% |
| Motor vehicles with an engine capacity of more than 1500 cc, excluding those listed under entry at S. No. 52B | 20% |
| Motor vehicles with an engine capacity exceeding 1500cc, commonly referred to as sports utility vehicles (SUVs), also include utility vehicles | 22% |
How Will the States Receive Their Share of the Compensation Cess?
The compensation is calculated based on the projected revenue growth rate of 14% annually from the base year 2015-16. If a state's actual revenue falls short of the projected revenue, the Compensation Fund compensates for the shortfall. For example, if a state's projected revenue for a year is ₹1000 crore, but the actual revenue is ₹900 crore, the shortfall of ₹100 crore will be compensated from the fund.The distribution process involves the following steps:
- States submit their revenue data to the GST Council.
- The GST Council verifies the data and calculates the shortfall.
- The Compensation Fund is used to disburse the calculated amount to the states.
The compensation cess period was initially set for five years, from July 1, 2017, to June 30, 2022. However, it has been extended till March 31, 2026, to bridge the revenue gap.
The total cess collection up to March 2025 is projected to be ₹8,66,706 crore, with compensation paid till September 2024 amounting to ₹6,64,203 crore. The remaining amount will be used to repay loans and interest.
What are the Methods to Secure Funds for Distributing Compensation Cess?
The central government has several options to acquire funds for distributing the GST compensation cess . Here are some:
- Market Borrowing: The government can raise funds by issuing bonds or taking loans. For example, issuing bonds worth ₹10,000 crore allows repayment over time with interest.
- Revising Cess Formula: Increasing the cess rate or expanding its coverage can generate more revenue. For instance, raising the cess on luxury cars from 15% to 18% can boost collections.
- Using Surplus Funds: The GST Compensation Fund, which accumulates cess collections, can be utilised. If it has a surplus of ₹5,000 crore, this can be allocated to states facing revenue shortfalls.
- Reducing Leakages: Strengthening tax compliance and reducing evasion can increase revenue. Improved monitoring, for instance, can generate an additional ₹2,000 crore for compensation.
Final Thoughts: Is GST Compensation Cess Here to Stay?
While the government initially promised this cess for only five years, its extension till 2026 suggests that businesses and consumers will continue to bear this additional tax for a few more years. Whether it will be extended further depends on the economy and GST collection in the coming years.As a business owner, staying updated with GST rules and compliance requirements and using a GST calculator is crucial to avoid penalties.
FAQS - FREQUENTLY ASKED QUESTIONS
Who is liable to pay the GST Compensation Cess?
The GST Compensation Cess is levied on suppliers of certain goods and services. Importers bringing such goods into India also need to pay this cess. However, exporters and businesses under the composition scheme are exempt from collecting it. Businesses can claim the input tax credit on the cess paid.
How long will GST Compensation Cess be applicable?
The GST Compensation Cess was originally to be levied for five years from July 1, 2017. However, the government extended it until March 2026 due to revenue shortfalls. The GST Council may further extend the period if states require additional compensation.
What goods and services attract GST Compensation Cess?
Goods like tobacco, cigarettes, aerated drinks, motor vehicles, coal, and luxury items attract GST Compensation Cess. Services generally do not attract this cess, except in specific cases where notified by the GST Council. The rates vary based on the type of product.
What are the current rates of GST Compensation Cess?
The cess rates vary depending on the product category. For instance, aerated waters attract a 12% cess, cigarettes have a mixed rate of percentage plus fixed per thousand units, and SUVs attract a 22% cess. The full list is provided under the GST Compensation Act.
Can Input Tax Credit (ITC) be used to pay late fees or penalties under GST?
No, ITC cannot be used to pay late fees, penalties, interest, or any other non-GST tax liabilities. It can only be utilised for the payment of GST output tax liability.
How is GST Compensation Cess calculated?
The GST Compensation Cess is calculated as a percentage of the transaction value under GST. The cess amount is added to the applicable GST rate. For example, if the GST rate is 18% and the cess rate is 12%, the total tax would be 30%.
How does the government distribute GST Compensation Cess to states?
The government distributes the cess based on each state's revenue loss. The base revenue for 2016-17 is taken, and a 14% annual growth rate is assumed. If a state’s actual GST revenue is lower than the projected amount, it is compensated accordingly.
How frequently is GST Compensation Cess paid to states?
The compensation is paid every two months to states. Provisional calculations are made, and payments are released accordingly. At the end of the transition period, surplus funds in the compensation fund will be distributed between the centre and states based on an agreed formula.
Has the GST Compensation Cess rate changed over time?
Yes, the GST Council periodically revises the cess rates. For example, in the 55th GST Council meeting, the cess rate on supplies to merchant exporters was reduced to 0.1%. Changes are notified through government circulars and amendments to the GST Compensation Act.
Can exporters claim a refund on the GST Compensation Cess?
Yes, exporters can claim a refund on the GST Compensation Cess paid at the time of export. This is done through the GST refund mechanism, which ensures that exported goods are tax-free. Exporters need to file a refund application online through the GST portal.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
