The Compensation Mechanism to States under the Goods and Services Tax (GST regime)

Table of Contents

Introduction:

After seventeen years of marathon journey of the most crucial tax reform in the country, entailing rounds of debates, deliberations and meetings and honest disagreements, the Goods and Services Tax came into effect in India on July 1,2017. The journey started in 2000 CE during Atal Bihari Vajpayee government with the setting up of a committee to suggest a GST model, followed by the formation of a task force under the chairmanship of Vijay Kelkar in 2003. There was no looking back since then and the Union government worked consistently along with the state governments to ensure its implementation.

Constitutional Scheme of GST:

A Bill was introduced in the Lok Sabha namely, the Constitution (One Hundred and TwentySecond Amendment) Bill, 2014 on 19.12.2014 proposing constitutional amendments to introduce the goods and services tax for conferring concurrent taxing powers on the Union as well as the States including Union territory with Legislature to make laws for levying goods and services tax on every transaction of supply of goods or services or both. Statement of Objects and Reasons of the Bill are as follows:

“STATEMENT OF OBJECTS AND REASONS

The Constitution is proposed to be amended to introduce the goods and services tax for conferring concurrent taxing powers on the Union as well as the States including Union territory with Legislature to make laws for levying goods and services tax on every transaction of supply of goods or services or both. The goods and services tax shall replace a number of indirect taxes being levied by the Union and the State Governments and is intended to remove cascading effect of taxes and provide for a common national market for goods and services. The proposed Central and State goods and services tax will be levied on all transactions involving supply of goods and services, except those which are kept out of the purview of the goods and services tax.

2. The proposed Bill, which seeks further to amend the Constitution, inter alia, provides for—

subsuming of various Central indirect taxes and levies such as Central Excise Duty, Additional Excise Duties, Excise Duty levied under the Medicinal and Toilet Preparations (Excise Duties) Act, 1955, Service Tax, Additional Customs Duty commonly known as Countervailing Duty, Special Additional Duty of Customs, and Central Surcharges and Cesses so far as they relate to the supply of goods and services;
subsuming of State Value Added Tax/Sales Tax, Entertainment Tax (other than the tax levied by the local bodies), Central Sales Tax (levied by the Centre and collected by the States), Octroi and Entry tax, Purchase Tax, Luxury tax, Taxes on lottery, betting and gambling; and State cesses and surcharges in so far as they relate to supply of goods and services;
dispensing with the concept of ‘declared goods of special importance’ under the Constitution;
levy of Integrated Goods and Services Tax on interState transactions of goods and services;
levy of an additional tax on supply of goods, not exceeding one per cent. in the course of interState trade or commerce to be collected by the Government of India for a period of two years, and assigned to the States from where the supply originates;

conferring concurrent power upon Parliament and the State Legislatures to make laws governing goods and services tax;

coverage of all goods and services, except alcoholic liquor for human consumption, for the levy of goods and services tax. In case of petroleum and petroleum products, it has been provided that these goods shall not be subject to the levy of Goods and Services Tax till a date notified on the recommendation of the Goods and Services Tax Council.
compensation to the States for loss of revenue arising on account of implementation of the Goods and Services Tax for a period which may extend to five years;
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The Constitution (One Hundred and First Amendment) Act, 2016 dated 08.09.2016 was passed to amend the Constitution of India. By Constitution (One Hundred and First Amendment) Act, 2016, new Articles 246A, 269A and 279A were inserted. Amendments were also made in Articles 248, 249, 250, 268, 269, 270, 271, 286, 366 and 368. Article 268A was omitted. Amendments were also made in Seventh Schedule of the Constitution in List I and List II.

For the purposes of this assignment, two essential section of the 101^st Constitutional Amendment are important :

“18. Compensation to States for loss of revenue on account of introduction of goods and services tax. Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax for a period of five years.

19. Transitional provisions. Notwithstanding anything in this Act, any provision of any law relating to tax on goods or services or on both in force in any State immediately before the commencement of this Act, which is inconsistent with the provisions of the Constitution as amended by this Act shall continue to be in force until amended or repealed by a competent Legislature or other competent authority or until expiration of one year from such commencement, whichever is earlier.

The GST Council:

The constitutional scheme embodying GST is facilitated through the composition of the GST Council under Article 279A. The GST Council is to consist of the Union Finance Minister, the Union Minister of State in charge of Revenue of Finance; and the Minister In-charge of Finance or Taxation or any other Minister nominated by each State Government. Clause (4) of Article 279(A) empowers the GST Council to make recommendations to the Union and the States on the aspects comprehended in sub-clauses (a) to (h) of Clause (4), which are extracted below:

“[…]

(a) the taxes, cesses and surcharges levied by the Union, the States and the local bodies which may be subsumed in the goods and services tax;

(b) the goods and services that may be subjected to, or exempted from the goods and services tax;

(c) model Goods and Services Tax Laws, principles of levy, apportionment of Goods and Services Tax levied on supplies in the course of inter-State trade or commerce under article 269A and the principles that govern the place of supply;

(d) the threshold limit of turnover below which goods and services may be exempted from goods and services tax;

(e) the rates including floor rates with bands of goods and services tax;

(f) any special rate or rates for a specified period, to raise additional resources during any natural calamity or disaster;

(g) special provision with respect to the States of Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Himachal Pradesh and Uttarakhand; and

(h) any other matter relating to the goods and services tax, as the Council may decide.”

Now it can be stated that GST is a destination-based single tax on the supply of goods and services from the manufacturer to the consumer, which has replaced multiple indirect taxes levied by the Central and State governments, thereby converting the country into a unified market. Among other benefits, GST is expected to improve the ease of doing business in tax compliance, reduce the tax burden by eliminating tax-on-tax (cascading effect), improve tax administration, mitigate tax evasion, broaden the organized segment of the economy and boost tax revenues for the exchequer..

GST has replaced 17 indirect taxes (8 Central + 9 state levels) and 23 Cesses of the Centre and states, eliminating the need for filing multiple returns and assessments and rationalizing the tax treatment of goods and services along the supply chain from producers to consumers. The taxes which has been subsumed in the GST are:

1:Central Taxes that have been subsumed under GST are:

a)Central Excise Duty

b)Duties of excise (Medicinal and Toilet Preparations)

c)Additional Duties of Excise (Goods of Special importance)

d)Additional Duties of Excise (Textiles and Textile Products)

e)Additional Duties of Customs(CVD)

f)Special Additional Duty of Customs

g)Service Tax

h)Central Surcharges and Cesses so far as they relate to supply of goods and services

2: State Taxes that have been subsumed under the GST are:

a)State Value Added Tax

b)Central sales Tax

c)Luxury Tax

d)Entry Tax(all forms)

e)Entertainment and Amusement Tax (except when levied by the local bodies)

f)Taxes on advertisements

g)Purchase Tax

h)Taxes on Lotteries, betting and Gambling

i) State Surcharges and Cesses so far as they relate to supply of goods and services.

GST comprises of five Acts, all passed in the year 2017 and implemented on July 1, 2017. These five Acts are:

a)Integrated Good And Services Tax Act,2017 .

b)Central Goods And Services Tax Act,2017 .

c)State Goods And Services Tax Act, 2017.(All states have their own Acts)

d)Union Territory Goods And services Tax Act 2017 –

e)The Goods And Services Tax ( Compensation To States ) Act, 2017

For the purposes of this assignment, I would now only deal with the Compensation Mechanism as has been stipulated in the The Goods And Services Tax ( Compensation To States ) Act, 2017.

The Scheme of Compensation Mechanism to States under the GST Regime:

GST as an idea was conceptualized to subsume all the taxes levied by the both Central and state governments on the supply of goods and services or both. It was indeed a herculean task to persuade the states to implement the GST. It was the persuasive power of the then Finance Minister Late Shri Arun Jetly which led to he consensus among all the representative of the states after many round of deliberations to implement the GST. States agreed to subsume their taxes in the GST only after getting an assurance that they would be compensated for the loss of revenue on account of the implementation of GST.

This Compensation Mechanism was incorporated in the 101^st Constitutional Amendment Act,2016 as under:

Statement of Objects and Reasons of the said Amendment Bill also raised a similar point:

2. The proposed Bill, which seeks further to amend the Constitution, inter alia, provides for—

“ xxxxxxxxxxxxxxxxxxxx

h) compensation to the States for loss of revenue arising on account of implementation of the Goods and Services Tax for a period which may extend to five years;

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A combined reading of the Statement of Objects and Reasons and Section 18 of the 101st Amendment Act states that it was the intention of the Parliament to provide by a law compensation to the states for loss of revenue arising on account of implementation of the goods and services tax for a period of five years.

Therefore, the very idea for the Compensation Scheme was given a constitutional and a statutory status. To realize the object of the section 18 of the 101^st Constitutional amendment Parliament enacted the Goods And Services Tax ( Compensation To States ) Act, 2017.

The Goods And Services Tax (Compensation To States ) Act, 2017:

The Preamble of the Goods and Services Tax(Compensation to States) Act, 2017 states as under:

An Act to provide for compensation to the States for the loss of revenue arising on account of implementation of the goods and services tax in pursuance of the provisions of the Constitution (One Hundred and First Amendment) Act, 2016.

Section 8 of the Compensation to the States Act, 2017 provides for levy and collection of cess which is as follows:

8. Levy and collection of cess. (1) There shall be levied a cess on such intra-State supplies of goods or services or both, as provided for in section 9 of the Central Goods and Services Tax Act, and such interState supplies of goods or services or both as provided for in section 5 of the Integrated Goods and Services Tax Act, and collected in such manner as may be prescribed, on the recommendations of the Council, for the purposes of providing compensation to the States for loss of revenue arising on account of implementation of the goods and services tax with effect from the date from which the provisions of the Central Goods and Services Tax Act is brought into force, for a period of five years or for such period as may be prescribed on the recommendations of the Council:

Provided that no such cess shall be leviable on supplies made by a taxable person who has decided to opt for composition levy under section 10 of the Central Goods and Services Tax Act.

(2) The cess shall be levied on such supplies of goods and services as are specified in column (2) of the Schedule, on the basis of value, quantity or on such basis at such rate not exceeding the rate set forth in the corresponding entry in column (4) of the Schedule, as the Central Government may, on the recommendations of the Council, by notification in the Official Gazette, specify:

Provided that where the cess is chargeable on any supply of goods or services or both with reference to their value, for each such supply the value shall be determined under section 15 of the Central Goods and Services Tax Act for all intra-State and inter-State supplies of goods or services or both:

Provided further that the cess on goods imported into India shall be levied and collected in accordance with the provisions of section 3 of the Customs Tariff Act, 1975, at the point when duties of customs are levied on the said goods under section 12 of the Customs Act, 1962, on a value determined under the Customs Tariff Act, 1975.

Section 3 ,7 and 10 of the Act provides as under:

3. Projected growth rate. The projected nominal growth rate of revenue subsumed for a State during the transition period shall be fourteen per cent. per annum.

7. Calculation and release of compensation. (1) The compensation under this Act shall be payable to any State during the transition period. (2) The compensation payable to a State shall be provisionally calculated and released at the end of every two months period, and shall be finally calculated for every financial year after the receipt of final revenue figures, as audited by the Comptroller and Auditor-General of India: Provided that in case any excess amount has been released as compensation to a State in any financial year during the transition period, as per the audited figures of revenue collected, the excess amount so released shall be adjusted against the compensation amount payable to such State in the subsequent financial year.

9. Returns, payments and refunds. (1) Every taxable person, making a taxable supply of goods or services or both, shall— (a) pay the amount of cess as payable under this Act in such manner;

(b) furnish such returns in such forms, along with the returns to be filed under the Central Goods and Services Tax Act; and

(2) For all purposes of furnishing of returns and claiming refunds, except for the form to be filed, the provisions of the Central Goods and Services Tax Act and the rules made thereunder, shall, as far as may be, apply in relation to the levy and collection of the cess leviable under section 8 on all taxable supplies of goods or services or both, as they apply in relation to the levy and collection of central tax on such supplies under the said Act or the rules made thereunder.

10. Crediting proceeds of cess to Fund. (1) The proceeds of the cess leviable under section 8 and such other amounts as may be recommended by the Council, shall be credited to a non-lapsable Fund known as the Goods and Services Tax Compensation Fund, which shall form part of the public account of India and shall be utilised for purposes specified in the said section.

(2) All amounts payable to the States under section 7 shall be paid out of the Fund.

The statute lays down the manner in which the compensation is to be paid for the first 5 years of the implementation of the GST (i.e. the transition period). Under Section 3 and Section 7 of the Compensation Act, the percentage of annual revenue growth of a State has been projected to be 14%. Under Section 7, if the annual revenue growth of a State is less than 14%, the State is entitled to receive compensation under the statute.

The compensation that is to be paid is the shortfall in the revenue growth. For instance, if the annual revenue growth of Maharashtra after GST implementation is 4%, it shall be compensated for the balance 10% – which is the shortfall. On the other hand, if the revenue growth of Tamil Nadu is 12%, it shall be compensated for the balance 2%. Under Section 9, the Centre has been granted the power to levy a GST Compensation Cess, which shall generate the funds required to compensate the States. The proceeds of this Cess have to be transferred to the GST Compensation Fund, from which the States shall be compensated for their revenue shortfall. Now, Section 10(2) of the Compensation Act states that “All amounts payable to the States under section 7 shall be paid out of the [GST Compensation] Fund”

Compensation cess is levied on five products considered to be ‘sin’ or luxury goods. For example, SUV vehicles (more than 4 metres) are charged 50 per cent GST, of which the GST tax rate is 28 per cent and the compensation cess is 22 per cent. The collected compensation cess flows into the Consolidated Fund of India, and then transferred to the Public Account of India, where a GST compensation cess account has been created. States are compensated bi-monthly from the accumulated funds in this account.

According to the the Goods and Services Tax (Compensation to States) Amendment Act 2018, in case of shortfall in GSTCC collection vis-à-vis GSTcompensation requirement, the earlier distributed surpluses (balance between collectionand disbursement of GST compensation) may be recovered from the union as well as stategovernments to pay current GST compensations to states.

Constitutional Challenge to the Compensation to the States Act

The validity of this Compensation Act was considered by the Supreme Court and upheld in its decision in Union of India v. Mohit Minerals (P) Ltd[1]. The Supreme Court examined the constitutional provisions relating to levy of GST in order to highlight the underlying constitutional and legislative scheme which is significant on various counts. The following can be culled out as the key attainments of this decision:

(i) The Supreme Court has placed extensive reliance upon the Statement of Objects and Reasons of the Amendment Act which highlights that the purpose of GST is to confer “concurrent taxing powers on the Union as well as the States including Union Territory with legislature to make laws for levying goods and services tax on every transaction of supply of goods or services or both”. This is a pin pointed acknowledgement of the change of constitutional design by the Amendment Act to enact the GST regime.

(ii) As an addendum, there is a further declaration that there is no omnibus subsumation of taxing fields under the Constitution by GST. According to the Supreme Court there is no dilution of the “residuary” legislative powers of Parliament in terms of Entry 97 of the List I of the Seventh Schedule of the Constitution. Thus this expansive legislative sphere can be gainfully pressed upon by Parliament to inter alia impose a “special GST” such as the compensation cess.

(iii) In respect of the arguments relating to cess, the Supreme Court has declared that cess “means a tax levied for some special purpose, which may be levied as an increment to an existing tax”. Thus the power of the legislature to impose GST inherently carries the power to impose cess on GST. There is nothing in the language of the Amendment Act “that henceforth no surcharge or cess shall be levied”.

(iv) The decision specifically highlights that it is already well settled that “two taxes/imposts which are separate and distinct imposts and on two different aspects of a transaction are permissible”. Thus insofar as GST and compensation cess operate in their distinct spheres, the validity of both has been sustained.

(v) The contention of “double taxation” is a non-starter in the opinion of the Court. It was observed that it is already settled that “if on the same subject-matter the legislature chooses to levy tax twice over there is no inherent invalidity in the fiscal adventure unless there are some other prohibitions”. Thus GST and compensation cess being “two separate imposts in law” are not prohibited. In fact compensation cess must be viewed as “an increment” to GST.

(vi) The Court also concluded that “[g]iving credit or set-off in the payment is legislative policy which had to be reflected in the legislative scheme”. Since there is no such indication in law, accordingly the claim that credit of tax paid on account of clean energy cess be made available to discharge the liability of compensation cess cannot be entertained.

Recent GST Compensation Standoff Between the States and the Central Government

The GST regime which was introduced four years ago and held as a becon of co-operative federalism faced a tremendous crisis in the fiscal year 2020. This crisis emerged due to the slump witnessed in the economy by the COVID-19 pandemic induced lockdowns. In its 41^st GST Council Meeting held in September 2020, the Finance Minister asserted that the Centre would not be able to compensate the states due to the Covid 19 pandemic which has resulted in the revenue shortfall.. The GST compensation requirement was estimated to be around Rs 3 lakh crore that year, while the cess collection was expected to be around Rs 65,000 crore. Thus there was an estimated compensation shortfall of Rs 2.35 lakh crore. States were given two options to remedy the situation and both require them to borrow from the market.The Centre contended that only ₹97,000 crore of the revenue shortfall was from implementation of the GST, while ₹1.38-lakh crore was due to extraordinary circumstances posed by an ‘Act of God’ (The Covid-19 pandemic). States could either borrow ₹97,000 crore, without having it added to their debt and with the principal and interest paid out from future cess collections, or they could borrow the entire ₹2.35-lakh crore shortfall, but will have to provide for interest payments themselves.The Finance Ministry had argued that higher borrowing by the Centre will push up interest rates and dent India’s fiscal parameters.

These recommendations were severely criticized by many states and they pointed out that Centre has both Moral and Constitutional duty to compensate the states.

The impasses ended in October 2020 when The finance ministry resolved that Centre will borrow Rs 1.1 lakh crore under a special window to meet the GST compensation shortfall this year in tranches and pass it on to states as a ‘back-to-back loan’.

Extension to the Compensation Cess

In the 45^th meeting of the GST Council held in lucknow on September,2021, the Council agreed to levy compensation cess for an extended period up to March 2026 to enable the Centre to repay the loans, including principal and interest taken, to compensate states for GST collection shortfall in the fiscal year 2020. As per the Compensation to the States Act,2017, states were to be compensated by the Centre for a period of five years till July 2022 for any shortfall in revenue due to GST implementation. But as the compensation shortfall enlarged during the pandemic, the Centre has borrowed funds to provided it to states as alternate to compensation in FY 21 and more borrowings are expected in FY22. Therefore, the extension was highly needed.

Conclusion:

The Goods and Services Tax regime can be regarded as the next big monumental change which was witnessed by India after the Liberalisation, Privatization and Globalisation (LPG) model of 1991. It goes without saying that it was a transformative reform which has substantially changed the way businesses are done in India. The beauty of GST lies in the way it has strengthened the the co-operative federalism of India. GST Council meets every year several times to deliberate upon the fiscal issues by bringing the representatives of each state and Union Territories which was not possible before the implementation of GST. The Constitutional status which was accorded to GST has made it indivisible. The fears of states that the implementation of GST will wreck havoc on their revenues has turned out to be false. The scheme of Compensation to States Mechanism has proved very efficient and friendly barring the one unfortunate incident. GST collection has continuously shown tremendous growth except the Financial Year of 2020-21 which is attributable to the COVID-19 induced lockdown. The gross GST revenue collected in the month of October 2021 is ₹ 1,30,127 crore (which is second-highest GST revenue ever collected, second only to that from April of 2021)of which CGST is ₹ 23,861 crore, SGST is ₹ 30,421 crore, IGST is ₹ 67,361 crore (including ₹ 32,998 crore collected on import of goods) and Cess is ₹ 8,484 crore (including ₹ 699 crore collected on import of goods). The recently extension granted to the Cess under the Compensation to the States Act will embolden the Central government to not shy away from its constitutional obligations and take tough decisions in the period of exigency. It has been only 4 years since the GST regime was introduced and India has witnessed large amount of revenue collection. With the co-operation of all the stakeholders, India is ready to achieve great heights in the coming days!

References:

Yojana Magazine, August,2017 Issue

Sacchidananda Mukherjee,Possible Impact of Withdrawal of GST Compensation Post GST Compensation Period on Indian State Finances ,No. 29102(January-2020)

https://indconlawphil.wordpress.com/2020/09/08/coronavirus-and-the-constitution-xxxv-examining-the-gst-compensation-crisis-guest-post/ https://www.scconline.com/blog/post/2018/12/03/positioning-gst-constitutional-scheme-and-validity-of-gst-compensation-act-a-case-comment/#_ftn1

https://www.hindustantimes.com/business/gst-revenue-for-october-2021-at-over-rs-130-lakh-crore-2nd-highest-ever-ministry-of-finance-101635754765103.html https://www.cbic.gov.in/resources//htdocs-cbec/legalaffairs/UoI_Mohit_Minerals_Ors.pdf http://idtcicai.s3.amazonaws.com/download/Constitution%20GST%20Amendment%20Act,%202016.pdf https://www.cbic.gov.in/resources//htdocs-cbec/gst/gst-compensation-to-states-act.pdf;jsessionid=5FDBF010C0AC9072FAC6AC5F1B8C8BE2

[1] (2018) SCC OnLine SC 1727.