GST Council meeting begins today: Compensation to states a big fault line

The first meeting of the GST Council of 2022 started today in Chandigarh. For the first time since July 2017 when the ‘one nation, one tax’ regime kicked in, the council meeting will be spread over two days largely due to the heavy load of agenda items and criticality of the issues awaiting the council’s adjudication. 

The hot potato of the meeting is going to be the issue of compensation to states and Union Territories. The issue of compensation has pitted several opposition ruled states against the Centre. With political differences between the Centre and these states at an all time high, the council’s capability to create consensus over economic issues will face an additional test as the Supreme Court ruled in May this year that the GST Council’s recommendations are not binding. 

The Finance Ministry set the tone on the issue late last week by notifying the extension of levying compensation cess by nearly 4 years under the GST regime till 2026. The notification brought in the GST (Period of Levy and Collection of Cess) Rules, 2022, under which the compensation cess will continue to be levied from July 1, 2022 to March 31, 2026.

The GST collections over the last few months have risen but the increase has come after a long duration of setbacks especially due to the slowdown created by the pandemic.

Under the Goods and Services Tax (Compensation to States) Act, 2017, states were guaranteed compensation at the compounded rate of 14 per cent from the base year 2015-16 for losses arising due to implementation of the GST regime for five years since its rollout (July 2017).

After the Lucknow meet in September 2021, Finance Minister Nirmala Sitharaman had stated that from June 2022 the regime of compensating states for revenue shortfall due to subsuming of taxes like VAT levied by the states will end. However the compensation cess, levied on luxury and demerit goods, was to continue till March 2026 primarily to repay the borrowings in 2020-21 and 2021-22 to compensate states for GST revenue loss.

In a special arrangement to meet the revenue shortfall and the resultant curtailed order to meet the resource gap of states due to short release of compensation, the Centre had borrowed and released Rs 1.1 lakh crore in 2020-21 and Rs 1.59 lakh crore in 2021-22 as lending to meet part of the shortfall in cess collection. Of this borrowed amount, the Centre repaid Rs 7,500 crore in 2021-22 as interest cost for the borrowing. Another Rs 14,000 crore is to be paid in this fiscal. The payment of the principal amount on these borrowings would start from 2023-24 and continue till March 2026.

The compensation fault line 

At the heart of the divide in the council lies the decision to continue levying compensation cess on sin and luxury goods till 2026 which doesn’t guarantee that states would continue to get compensated till that period for losses in revenue incurred in comparison to the pre-GST era. 

This issue had reared its head at the Lucknow meeting of the GST Council in September last year but the meet couldn’t broker a consensus. It rose again during the pre-budget meetings and as well as the last meeting of the council in December. 

The opposition ruled states aren’t happy with the idea of ending the compensation before they arrive at a “revenue neutral” point. The Centre’s compulsion is that as per the GST law, the states' compensation has been increasing at 14 per cent compounded growth rate while the cess collection has not kept pace with it. The COVID-19 deceleration widened the gap further between the states’ protected revenue and the actual revenue collected including reduced cess collection.

However, states are demanding an extension of the compensation regime under GST and they are all set to flag this demand in the two day council meeting. They are likely to seek an extension of compensation for additional three years beyond the June 30 deadline. 

Opposition ruled states are using the data cited in the agenda papers circulated for the meet. They claim that the the state-wise gap between the protected revenue and the post settlement gross SGST revenue (including ad-hoc settlement) for FY 2021-22 as compared to FY 2020-21 had risen as the all-India average shortfall for 2021-22 was 27.2 per cent versus 37.9 per cent in 2020-21.

A look at the data collated for the meeting shows that while Sikkim, Mizoram, Nagaland, Arunachal Pradesh and Manipur recorded a positive gap, states like Himachal, Chhattisgarh, Punjab, Uttarakhand, Puducherry and Punjab recorded the steepest negative revenue gap between the protected revenue and post-settlement gross state GST revenue in FY22.

There are three options for the council to look at – extending the compensation to states/UTs after lowering the rate of protected revenue, or providing compensation to the few states that have been affected severely due to Covid, or to reject the demand totally. Now, the Council will take a final call.

Also read: Tax relief by GST Council on premium for life, medical insurance cover unlikely