Shortfall of GST Compensation Issue - Update from the 42nd GST Council Meeting

Background - What is GST Compensation?

During the implementation of GST, states had to transit from the indirect taxes’ regime into the new GST regime. This resulted in a tremendous loss of revenue for the states, together with them ceding almost all their powers to impose local-level indirect taxes.

Thus, a provision was made to compensate the states for such loss of revenue by the center agreeing that revenue shortfalls arising from the transition to the new indirect taxes’ regime would be made good from a pooled GST Compensation Fund for a period of five years that is set to end in June 2022. This payment was funded through a "Compensation Cess” that is levied on demerit goods.

What is the shortfall arising in GST Compensation Cess Collection?

Revenues from the imposition of cess started declining in August 2019. As a result, the payment of GST compensation to states became a major issue. The amount of cess calculated during 2019-20 was Rs. 95,444 crores. However, the payment made to states in the year was Rs. 1.65 lakh crores. The Centre had to release the GST compensation to states from the cess collected in the years 2017-18 and 2018-19. Know more about the GST Compensation to States: The Corona Effect. Read now!

How did the COVID-19 pandemic affect GST Compensation Cess Collection?

The COVID-19 pandemic had an extremely adverse effect on the GST Compensation Cess Collection. The shortfall in GST Revenues for the year 2020-21 is expected to be Rs. 3 lakh crores. However, collection from the compensation cess is expected to be only Rs. 70,000 crores. Thus, a gap of Rs. 2.3 lakh crores has to be filled for the smooth functioning of the states.

Update from the 42nd GST Council Meeting regarding the GST Compensation Issue

Finance Minister Smt. Nirmala Sitharaman while briefing the Press on 5th October 2020, said that "Compensation cess collected this year so far, amounting to approx. Rs. 20,000 Crore, will get disbursed to all states” on 5th October 2020 itself. It has also been decided to extend the levy of Compensation Cess beyond June 2022.

For the pending shortfall, two borrowing options have been giving to the states, the loans in both the cases will be paid from the cess itself:

Option 1: To provide a special window to states, in consultation with the RBI, to provide the ₹ 97,000 crores at a reasonable rate of interest. This money can then be repaid after 5 years from the collection of cess.

Option 2: Entire GST compensation gap of ₹ 2,35,000 crore of this year can be met by the states, in consultation with the RBI.

Key features of the options given to the states

1. ON REPAYMENT SCHEDULES

• Interest on the borrowed amount will be the first charge on the cess which gets collected beyond 5 years;
• The next charge could be 50% on the principal amount which gets borrowed

2. CESS WHICH GETS COLLECTED AFTER 5 YEARS

• 1st charge to be on interest on the borrowed amount
• 50% of remaining to be towards payment of the principal amount
• Next 50% to be paid towards the COVID-19 affected compensation gap

The gap in compensation arising due to the extraordinary situation due to COVID-19 will be paid out of the cess which gets collected after 5 years

3. ASSESSMENT OF THE FINANCE COMMISSION OF INDIA

It has been decided that the borrowing that states have been offered to meet the GST compensation gap, is beyond the 5% GSDP borrowing limit. Thus, the borrowing won't be taken into consideration in the Finance Commission's assessment of state borrowings vs. GSDP. Hence, it won't affect states in the eyes of the Finance Commission of India.

Does the interest or principal amount need to be paid from the state’s own resources?

The Finance Minister announced that neither the interest nor the principal needs to be paid from the state's own resources. The cess will take care of it, so it is not going to be a burden on the states. The entire compensation is going to be paid back to the states. This includes compensation shortfall which has arisen due to GST implementation and due to COVID-19.

The decision of the States in the options presented by the Finance Minister

While around 20 states had opted for Option 1, some states did not choose any option & wanted that it should be the Centre which borrows. There was a discussion on this and it was felt that another meeting is required to reach a consensus.

Thus, states have requested a 7-day window to think over and get back to the FM. However, it must be noted that these options would be available only during the current year. The situation will be reviewed next year and decisions will be made on what is best for the country.

Changes made in the options in consultation with the states

The Finance Minister also mentioned the changes made in the Options, in consultation with the states. Thus, instead of Rs. 97,000 Crore to be borrowed in Option 1, the amount has now been extended to Rs. 1.1 Lakh Crores.

Conclusion

Finance Minister Smt. Nirmala Sitharaman has announced that because no consensus was reached during the 8 hours long 42nd GST Council Meeting, this issue will be taken up in the next meeting which has been scheduled for 12th October 2020.

Understand the GST Compensation Cess in detail. Read now!