What Is Compensation Cess under GST?

What is GST compensation cess? The Goods and Services Tax (GST) Act, 2017 levies the GST compensation cess. This cess came into force from 1st July 2017 along with the GST law. This cess acts as a bridge, connecting the gaps that occurred on the cessation of the prior indirect tax regime. 

With the introduction of GST, there was a  shift to the destination-based taxation model from the former manufacturing-based model at the time of excise law. It means that the revenue will now accrue to the states where the goods or services will get consumed.

This model did not go well with the states that had spent heavily on building the manufacturing plants to increase their indirect tax revenue. This GST cess compensates those states for the loss in revenue for five years. The period of five years can be increased if decided by the GST council.

Collection of the Compensation cess

Suppliers of specified goods and services apart from the exporters are liable to collect the GST compensation cess. Compensation cess is also applicable on certain import items (where Custom Duty is applicable), mostly on the luxury items and demerit categories like alcoholic beverages, tobacco, etc.

It will also include compensation cess chargeable on certain goods imported to India. In case if compensation cess gets paid on exports, the exporter can claim a refund of the same.

No cess shall be applicable 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 (CGST) Act.

Goods that get covered under the GST compensation cess

Following is the list of goods that get covered in the GST compensation cess:

Also Read: Types of GST in India - What is CGST, SGST and IGST?

How to calculate cess on GST?

GST cess is levied on goods' price before the charging of any GST. If the compensation Cess on ovoids is Rs 400 per tonne and the selling price for a tonne of ovoid is Rs 8,000, then GST Cess of Rs. 400 gets attracted. Apart from that, GST at a usual applicable rate will also get attracted.

Let us assume that the value of goods (assessable value) imported to India is Rs 200 and the GST rate is 18%, and customs duty is 10%. If the goods attract GST Compensation Cess, this would be levied on rupees two hundred and twenty, as Compensation Cess is not levied on Integrated Goods and Services Tax (IGST).

The compensation cess on goods imported into India shall be applicable as per section 3 of the Customs Tariff Act, 1975. It will be levied at the point when customs duties are levied on the said goods under section 12 of the Customs Act, 1962, on a value determined under the Customs Tariff Act, 1975. If the goods are exported outside India under bond, it will make the exporter eligible for a refund of cess (input tax) paid at the time of purchase.

The provisions and rules of the CGST Act, 2017 relating to the input tax credit, assessment, short-levy, interest, appeals, penalties will be applicable on the cess of the intra-state supply of goods and services. In the case of inter-State supplies, the IGST Act, 2017 and the Rules made thereunder will apply.

Distribution of GST cess across States

The process of distribution of the GST cess across the states is as follows:

Step 1: Start with the base year revenue computation.

Base revenue = Tax revenue of the state in the Financial year 2016-2017.

Step 2: Assuming a growth rate of 14%, calculate projected revenue for each financial year.

Note: The growth rate of 14% is used to determine the state's revenue had GST not been initiated. Continue with this calculation for five years, which is the transitional period.

Step 3: At the end, calculate the cess payable for each of the financial years as follows

Expected Tax collection for that particular financial year(based on 14% growth)    XXXX

                                                             (-)    Actual Revenue earned by the state    XXXX

                                                             =   Compensation payable to the state    XXXX

After doing this calculation, the amount gets paid to the state. This payment gets released every two months to the states. If the fund has any surplus at the end of the transition period, the same will be distributed between the centre and the state. 

The projected revenue that the State could earn in the absence of the goods and services tax till the end of the relevant two months period will be calculated on a pro-rata basis. This will be a percentage of the total projected revenue for any financial year during the transition period.

In case no compensation is due to be released in any financial year, or if any excess amount is given to a State in the previous year, this amount shall be refunded by the State to the Central Government.

Base Year Inclusions

The following items will get included in the calculation of the base year.

1. Works contract tax, Value Added Tax (VAT), or other taxes collected by the states as per entry fifty-four of the state list of the Constitution of India.

2. Entry tax and other taxes charged by the state government as per entry fifty-four of the state list of the Constitution of India.

3. Excise duty levied on medicinal and toilet preparation. The same gets levied by the State government but collected by the Central government as per article 268 of the Constitution of India.

4. Taxes on luxuries, advertisement.

5. Any cess or surcharge or fee leviable 

Base Year Exclusions

1. Any tax charged under any law as per entry fifty-four of the state list of the Constitution of India on purchase or sale of high-speed diesel, petrol, petroleum crude, natural gas, ATF (aviation turbine fuel), and alcohol meant for human consumption.

2. Any cess levied by the  Government of a state on the sale or purchase of petroleum crude, high-speed diesel, motor spirit (commonly known as petrol), natural gas, aviation turbine fuel, and alcoholic liquor for human consumption.

3. The entertainment tax levied by the State but collected by local bodies, under any law for the time being in force.

Implication of Cess under GST

There has been a shift from pre-existing consumption-based indirect taxation to destination-based taxation.  Many states opposed such a move. So, the GST compensation cess was invoked by the Central government to address this issue. The manufacturing states will receive funds on account of this cess. Meanwhile, they will change their stance to increasing consumption in their states to raise their indirect tax revenue. This will, in turn, raise the economic growth rate of the country.

Due to the current pandemic situation, the cess collection has been significantly less. As a result, the Central government has not been able to honour its dues to the states. It can either revise the GST cess formula or borrow funds from the market.

Also Read: History of GST in India - Benefits of GST Implementation

Conclusion

On 28th May 2021, a GST council meeting was held. The Central Government proposed borrowing Rupees 1.58 lakh crore to fund the GST compensation cess fund collection shortfall. In the current year, the Central Government expects the cess payment of around three lakh crore, assuming that the economy grows at around 7% per annum. It is the second consecutive time that the cess fund fell short of honouring the payment obligation. The Central Government is even proposing to amend the original cess computation formula to lower its burden. Since it was a constitutionally passed mandate, it is highly uncertain that the  Central Government will succeed in that pursuit. 

We hope from this article; we have been able to clear your doubts regarding the cess rate in GST. Learn more about GST, business and accounting tips and other useful information by downloading the Khatabook app.