INTRODUCTION

What is GST Compensation?

Manufacturing States were concerned about a potential revenue loss as the nation transitioned to the Goods and Service Tax. The new system substituted a consumption-based taxing structure for one that was production-based. A compensation mechanism was put in place for five years to allay this concern. “Section 18 of the Constitution (101st) Act of 2016 [i] states that the Parliament shall, on the recommendation of the GST Council, provide compensation to States for loss of revenue arising on account of implementation of the Goods and Services Tax for a period of five years from the date of its implementation.[ii]”

“The Indianized GST paradigm was created to promote cooperative federalism. It is based on three fundamental principles: revenue neutrality, tax sharing between the federal government and the states, and the provision for GST compensation.”

A. The need for Compensation

State revenue was safeguarded at 14% annually over base year revenue in 2015–16 during the transition period. There was already a compensation mechanism in place when Value Added Tax (VAT) was implemented in the early 2000s. It did function effectively, but after a while, when the States’ revenue increased significantly, it was stopped.

The provision for GST compensation could be viewed as a payment in exchange for the states giving up their different tax advantages. Additionally, it was created in anticipation of a conceivable revenue shortfall for the states. While it is claimed that these rules support cooperative federalism, the GST compensation has been restricted to the first five years of GST for an unidentified reason. The initial five-year threshold, nevertheless, is debatable.

The GST (Compensation to States) Act of 2017 guarantees that the States would receive 100% compensation for any revenue losses incurred during the first five years after the implementation of the GST.[iii]

FLAWS IN COMPENSATION SYSTEM

The structure of compensation payment has these major faults:

1. One, it was overly optimistic to anticipate that State indirect tax income would increase by 14% yearly in the post-GST era. In 28 States, the average annual growth rate of taxes absorbed by GST from FY13 to FY17 was only 8.09%. Given that large states like Maharashtra, Uttar Pradesh, and Tamil Nadu saw just a 5-7% growth in their indirect tax collection prior to the introduction of the GST, this was something that was predictable.[iv]
2. Second, while the intended growth is the same for all States, but tax revenue growth rates vary among States, States with lower revenue growth tend to get greater compensation payments. Because each State’s economy is unique, using a single growth rate has produced a lot of anomalies.
3. Thirdly, certain States may become fiscally irresponsible as a result of the protected growth in GST revenue. In some States, there is a greater reliance on compensatory cess. The fact that compensation payments made up more over 20% of tax receipts in FY22 for States/UTs like Punjab, Bihar, Delhi, and Karnataka is cause for concern.

A. Is the Compensation Amount enough?

The amount of compensation provided by the Centre gradually increased, suggesting that state GST collections rose more slowly in 2019–20.   The recent economic recession can be held responsible for this.

This in turn can be attributed to the insufficient collection of compensation cess.

Figure 2: Cess Collection and Compensation (2017-20)

Source: Union Budget Documents; Ministry of Finance; GST Council; Lok Sabha Questions; PRS.[v]

B. Why did the States seek its extension and why has the government granted it? 

Some States claim that since the COVID-19 outbreak and the ensuing lockdown, their tax revenues have not yet fully recovered. They requested an extension of the GST compensation; some requested a five-year extension while they waited for things to get better. Beyond June 30, 2022, at least 12 States requested an extension of the compensation system.

“The Central Board of Indirect Taxes and Customs (CBIC) extended the collection of the Goods and Services Tax (GST) Compensation Cess until 31 March 2026 via Notification No. 1/2022-Compensation Cess dated 24 June 2022.” It was revealed at the 45th GST Council meeting that the money raised from the Compensation Cess in the years after June 2022 until April 2026 will be used up to pay back the borrowings and debt service incurred to close the deficit between 2020–21 and 2021–22.[vi]  As a result, even if the extension has been granted, the States receive no financial benefit from it.

States most likely to be affected by the non-extension of GST Compensation

“According to the RBI analysis, the states where the percentage of GST compensation in tax collection has typically exceeded 10% are Puducherry, Punjab, Delhi, Himachal Pradesh, Goa, and Uttarakhand. These states stand to suffer the most from the termination of the compensation regime.[vii]

The need for GST compensation varies greatly amongst states. Maharashtra, Karnataka, Gujarat, Tamil Nadu, and Punjab received the most compensation during the five-year transition period (July 2017 to June 2022).[viii]

The combined GST revenue for all states, which includes SGST and devolution from CGST, is budgeted to be higher than the revenue expected in 2022–2023, according to the RBI, with a guaranteed 14% annual growth. According to their budget projections, ten states are likely to fall short of a 14% GST rise. The apex bank claims that moving forward, in the absence of GST compensation, the states will need to increase compliance, stop leaks, and broaden their tax bases in order to increase their revenue.[ix]”

 SHOULD COMPENSATION CONTINUE?

The major question is whether the compensation regime should continue.

A. Arguments for extension of GST Compensation Cess

• States assert that the two primary reasons their revenue position hasn’t improved are the implementation of the GST and how the epidemic has affected revenue collection.
• “Being a new state, we have limited sources of revenue. We will demand in the GST Council for extension of the compensation scheme or in some other way compensate for the revenue loss. We will have an annual loss of about Rs 5,000 crore,” said Uttarakhand Finance Minister Prem Chand Aggarwal. Finance Ministers of Kerala and Tamil Nadu also raised concerns, seeking an extension.[x]
• They also expect a bigger deficit due to the poor rate of revenue growth and growing costs. States are asking for a five-year extension of compensation in light of all of these factors.
• States claim that compensation is necessary since the economy has not yet fully recovered from the Covid crisis and because the Russia-Ukraine situation has created new problems. Taking this into account, extending compensation starting on July 1 will assist States in bridging the resource gap and aiding in the recovery of the economy. State-level development will support overall national growth.

B. Arguments against extension of GST Compensation Cess

• There are a number of reasons why the extension is not required. One, the GST collections in India as a whole increased by a healthy 19% in FY22 over FY21. While Punjab had a 24% increase in GST revenue, Odisha saw a 42% increase in revenue. In terms of GST, it is evident that the system is well on the road to recovery and that the difficulties caused by the pandemic have largely passed. States with high growth rates in collecting are those whose production exceeds consumption. There wouldn’t be a need to support the United States any longer if the economy continues to improve.
• Second, States must be weaned off of their reliance on compensation payments to make up for their budgetary shortfalls. Even throughout the pandemic, several States continued to give away freebies and pointless subsidies, which left their finances in a precarious situation. It is obvious that the pledged payments give them permission to carry on in this way.
• Third, rather than relying solely on these payments, States should be encouraged to raise collections by stopping leaks and enhancing compliance.
• Four, continuing the payments may necessitate greater government borrowing, which could have an impact on bond yields and the financial markets.
• Five, it might be better to stop the compensation payments now rather than two or three years from now, when States will have a new set of justifications for why it should be continued.

CONCLUSION

Thus, based on the above discussion it is clear that the primary issue related to providing

adequate GST compensation has been challenging from the perspective of the Central

Government. The economic downturn caused by the pandemic and the geopolitical tensions has affected the Indian taxation system also. The non-extension of the GST Compensation scheme has affected the revenues of several States, with several States insisting on extending the period of the scheme. There have been no easy answers to resolve the crisis, with States insisting that they were assured at the time of enactment of the GST that the Centre would provide them with compensation whenever there was a need.”

[i]  Constitution (101st) Act 2016, s18.

[ii] Shishir Sinha, ‘All about the GST Compensation Fund’ (The Hindu Businessline, 1 July 2022) <https://www.thehindubusinessline.com/blexplainer/all-about-the-gst-compensation-fund/article65598067.ece> accessed 29 June 2023.

[iii] K J Joseph and Anitha Kumary L., ‘India’s GST Paradigm and the Trajectory of Fiscal Federalism: An Analysis with Special Reference to Kerala’ (2023) 71 (1) IEJ <https://journals.sagepub.com/doi/abs/10.1177/00194662221146640?journalCode=ieja> accessed 29 June 2023.

[iv] Lokeshwarri SK, ‘GST Compensation to States can stop’ (The Hindu Businessline, 23 June 2022) <https://www.thehindubusinessline.com/opinion/gst-compensation-to-states-can-stop/article65554145.ece> accessed on 29 June 2023.

[v] Suyash Tiwari, ‘Cost of GST compensation’ (The PRS Blog, 25 August, 2020) <https://prsindia.org/theprsblog/cost-of-gst-compensation> accessed 29 June 2023.

[vi] ‘Government extends levy of GST Compensation Cess till 31 March 2026’ (EY, 27 June 2022) <https://www.ey.com/en_in/alerts-hub/2022/06/government-extends-levy-of-gst-compensation-cess-till-31-march-2026#:~:text=It%20was%20levied%20for%20a,Cess%20till%2031%20March%202026.> accessed 29 June 2023.

[vii] Sanjay Vijayakumar, ‘T.N. among top five States receiving GST compensation, says RBI study’ (The Hindu, 30 January 2023) <https://www.thehindu.com/news/national/tamil-nadu/tn-among-top-five-states-receiving-gst-compensation-says-rbi-study/article66447109.ece> accessed 29 June 2023.

[viii] Dilasha Seth, ‘End of GST compensation to jolt six states most, says RBI’ (Mint, 19 January 2023) <https://www.livemint.com/news/india/end-of-gst-compensation-to-jolt-six-states-most-says-rbi-11674061417768.html> accessed 29 June 2023.

[ix] ‘End of GST compensation to hit 6 states hard: RBI’ (Fortune India, 19 January 2023) <https://www.fortuneindia.com/macro/end-of-gst-compensation-to-hit-6-states-hard-rbi/111219#:~:text=The%20RBI%20says%20during%20the,%2C%20Tamil%20Nadu%2C%20and%20Punjab. accessed> 29 June 2023.

[x] Hera Rizwan, ‘Explained: States Are Asking For An Extension On GST Compensation. What Does This Mean’ (Explainers, 1 July 2022) <https://www.indiatimes.com/explainers/news/states-are-asking-for-an-extension-on-gst-compensation-what-does-this-mean-573691.html> accessed 29 June 2023.

#aklegalassociates #criminallawyer #lawyer #lawfirm #GSTCompensation #CooperativeFederalism #IndianEconomy #TaxReform #RevenueSharing