Inadequate Compensation By Centre Under GST

Economic Affairs Tax System

Chhattisgarh Chief Minister Bhupesh Baghel has written to Prime Minister Narendra Modi asking that the cut-off date for ending compensation to the States be moved from 2021-22 to 2026-2027. He had also highlighted the same at the recent meeting with NITI Aayog.

He pointed out that Chhattisgarh as a producer state was suffering owing to the delay and inadequate compensation received by the Centre.

What is the issue?

The Centre had written to states that due to lower GST collections, the compensation cess might not be enough to pay for losses arising out of the tax system.

The upcoming Goods and Services Tax (GST) Council meeting is scheduled on December 18, 2019, where states are expected to raise their concerns and resentment on not being paid their dues on time or incomplete dues as promised by the centre.

Many states especially the producer/manufacturer states have expressed apprehensions about not getting their compensation on time or at all.

Some states were forced to incur debts to meet their expenses which were dependent on GST compensation money.

States have been demanding the centre’s direct response in place of passing resolutions in their respective state assemblies to extend the compensation cut off dates.

What is the need for a Compensation cess?

The provision of Compensation cess was introduced for providing compensation to the States for the loss of revenue arising on account of implementation of the Goods and Services Tax.

The compensation cess is a cess that will be collected on the 187 supply of select goods and or services or both till 1st July 2022.

It is levied on certain goods such as luxury cars, aerated drinks, and pan masala and tobacco products, over and above the rate of 28%.

The compensation is paid to the states once every two months out of this compensation cess collected on taxes on sin & luxury goods. In June-July 2019, the centre’s compensation to states was a mere 27,955 crore.

This could be to a slowdown in consumer demand.

As per the Goods and Services (Compensation to States) Act, 2017, if a state’s revenue growth falls below 14% in a year, the centre would bridge the shortfall for the first five years.

What is Goods and Services (GST) Tax?

To make India a unified market, a destination-based Goods and Services indirect tax system was enforced on 1, July 2017 under the 101st Constitutional Amendment Act.

It is calculated at every stage of the product life-cycle from manufacturer to consumer and it is collected at every value-addition stage.

The consumer at the final stage is supposed to pay only his part of the tax (the value addition at that stage) and not that of the entire supply chain.

A GST council headed by the Finance Minister is empowered to take key decisions on issues related to GST.

The GST Act authorises the Parliament to compensate states for any revenue loss owing to the GST implementation.

Effects on state due to inadequate compensation under GST implementation:

Taxes constitute 60% of the states’ income, if not compensated adequately the dues could disrupt not only the budgets and the planning processes but also the economies of the states.
After GST implementation, the key taxes that earned major revenue for the states like the sales tax, entertainment tax, Octroi and entry tax, purchase tax, luxury tax, taxes on lottery, betting and gambling etc. have been completely subsumed under GST.
To run their economy hassle-free, states need the compensation money.
It is mentioned in the GST Act, that it is mandatory for the Parliament to provide compensation to states for any revenue loss to states owing to GST implementation.
This compensation is made in the form of compensation cess that is levied on key sin and luxury goods like tobacco products, pan masala, aerated drinks, luxury cars over and above the rate of 28% for payment of compensation to states.
However, due to lower GST revenue collections, the centre has compensated only half the promised amount and a sum of over INR 30,000 Crore is due on centre.
That is why states have been for long demanding extension of the compensation cut off dates from 2021-2022 to 2026-2027 to make up for the heavy losses suffered by them.

What Government promised Vs The Reality?

The government had targeted more than INR 6 Lakh Crore of GST collections for FY 2019-2020. However, only about 50% of the stated amount has been collected so far.
The centre had targeted more than 1 Lakh Crore of compensation cess of which only 64,528 Crore has been collected so far.
State governments are considering legal recourse against the centre if dues are not cleared immediately. Funds up to 30,000 Crore are due on centre.

Causes of lower revenue collections under GST

GST tax evasion: The Government of India detected GST evasion worth INR 20,000 Crore in 2018-2019. This leads to leakage of government revenues. Malpractices like non-issuance of invoices, under-reporting of sales, claiming false credits, collection of taxes but not depositing with the exchequer etc. have the potential to minimize tax flow of companies, thus lowering revenue collection.
The slowdown in consumer demand: The sluggish revenue collections are far away from meeting the 1 Lakh Crore target and states have not been compensated adequately. There is a definite slowdown in consumer demand.
Input tax credit frauds: Businesses have been overvaluing and faking invoices to claim a refund of an input tax credit. This is causing a major loss in revenue collections to the centre.
Lack of consensus between states on various subjects: states have been unwilling to bring petroleum products under GST and also there is no common opinion on reduction in the number of tax slabs and tackling of the contentious dual-rate item—the lottery.

Exemption of key revenue items from GST: A number of items have been exempted from the GST ambit and therefore, the GST collections have not been meeting the expected target collections.
Complications under GST: There have been a number of tax slabs from 0%, 5%, 12%, 18% and 28% highest being 40%, which is further complicating the revenue collection process.

Way Forward

The government must build up a robust structured mechanism to strengthen tax compliance and minimize tax evasion. Introduction of e-invoicing of business-to-business transactions and new and simplified GST returns could be a step in this direction.
The centre should make efforts to boost the consumption demand in the economy which will lead to higher GST collections.
The efforts should be aimed towards simplifying the whole GST process to nullify the possibilities of any halts and delays.
The states must reach a consensus on cutting down the tax slabs and bringing the petroleum products and electricity under GST boost revenue collections.
Strict verification norms should be implemented to avoid any kind of input tax credit frauds that have the potential of harming the economy.
Centre must compensate adequately to states on time and must avoid delays to avoid resentment on the part of states.
In a nutshell, GST is based on federalism and centre must allay all the fears and concerns of the states because GST can be a real success only with the participation of states.

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