The introduction of GST transformed India’s indirect tax landscape, merging various central and state-level taxes into a unified system. However, this transition left many states grappling with revenue shortfalls, as they had to forgo their previous taxing powers. To address this challenge, the central government introduced GST Compensation Cess, a targeted levy on specific goods and services.
In this blog, we’ll explore the purpose, application, and current relevance of GST Compensation Cess in India, especially with regards to the latest GST Council Meeting while delving into its nuances with detailed examples, updates, and discussions.
What is GST Compensation Cess?
Compensation cess was introduced to compensate states for any potential revenue loss due to the transition from the old tax structure to the Goods and Services Tax (GST). The cess primarily targets goods and services that are either luxury items or products that are potentially harmful to health, such as tobacco, aerated drinks, and high-end vehicles.
Who Collects Compensation Cess and How Is It Applied?
Compensation cess is collected by:
- Manufacturers of goods covered under the cess schedule.
- Importers bringing such goods into India.
- Suppliers involved in selling these goods and services within the country.
The cess is over and above GST, meaning businesses must calculate and remit it separately for applicable transactions. All taxpayers other than exporters and composition taxpayers will collect compensation cess and if compensation cess is paid for exports, the exporter can claim a refund of the same.
Goods Covered Under GST Compensation Cess in India
Compensation cess applies only to a select group of goods, ensuring the tax targets revenue-generating categories. Below is a comprehensive GST cess rate list with compensation cess on cars, tobacco products, and more such compensation cess examples:
| Category | Sub-category/Description | Compensation Cess Rate |
| Tobacco Products | Cut tobacco | ₹0.14 per unit |
| Unmanufactured tobacco (with lime tube), branded | ₹0.36 per unit | |
| Unmanufactured tobacco (without lime tube), branded | ₹0.36 per unit | |
| Branded tobacco refuse | ₹0.32 per unit | |
| Tobacco extracts and essence, branded | ₹0.36 per unit | |
| Tobacco extracts and essence, unbranded | ₹0.36 per unit | |
| Filter khaini | ₹0.56 per unit | |
| Jarda scented tobacco | ₹0.56 per unit | |
| Cheroots and Cigars | 21% or ₹4,170 per thousand, whichever is higher | |
| Cigarillos | 21% or ₹4,170 per thousand, whichever is higher | |
| Cigarettes (length ≤ 65mm) | 5% + ₹2,076 per thousand | |
| Cigarettes (length > 65mm but ≤ 70mm) | 5% + ₹2,746 per thousand | |
| Cigarettes (length > 70mm but ≤ 75mm) | 5% + ₹3,668 per thousand | |
| Cigarettes of tobacco substitutes | ₹4,006 per thousand | |
| Cigarillos of tobacco substitutes | 12.5% or ₹4,006 per thousand, whichever is higher | |
| Smoking mixtures for pipes and cigarettes | 290% | |
| Branded hookah or gudaku tobacco | ₹0.36 per unit | |
| Hookah tobacco or gudaku (not branded) | ₹0.12 per unit | |
| Other water pipe smoking tobacco (unbranded) | ₹0.08 per unit | |
| Other smoking tobacco (branded) | ₹0.28 per unit | |
| Other smoking tobacco (unbranded) | ₹0.08 per unit | |
| Homogenized or reconstituted tobacco (branded) | ₹0.36 per unit | |
| Chewing tobacco (without lime tube) | ₹0.56 per unit | |
| Chewing tobacco (with lime tube) | ₹0.56 per unit | |
| Preparations containing chewing tobacco | ₹0.36 per unit | |
| Pan masala (gutkha) containing tobacco | ₹0.61 per unit | |
| Other goods containing tobacco (gutkha), branded | ₹0.43 per unit | |
| Other goods containing tobacco (gutkha), unbranded | ₹0.43 per unit | |
| Snuff | ₹0.36 per unit | |
| Preparations containing snuff | ₹0.36 per unit | |
| Coal and Lignite Products | Coal, ovoids, briquettes, and similar solid fuels manufactured from lignite | ₹400 per tonne |
| Petroleum Coke | ₹400 per tonne | |
| Anthracite Coal | ₹400 per tonne | |
| Aerated Beverages | Aerated waters | 12% |
| Lemonade | 12% | |
| Sweetened flavored beverages | 12% | |
| Automobiles | Motorcycles of engine capacity > 350cc | 3% |
| Motor vehicles for transporting ≤ 13 persons, including driver | 15% | |
| Petrol, LPG, or CNG vehicles (engine ≤ 1200cc and length ≤ 4000mm) | 1% | |
| Diesel vehicles (engine ≤ 1500cc and length ≤ 4000mm) | 3% | |
| Luxury vehicles (engine > 1500cc, length > 4000mm) | 20% | |
| SUVs (engine > 1500cc, length > 4000mm) | 22% | |
| Luxury Goods | Yachts, pleasure crafts, and sports vessels | 3% |
| Aircraft for personal use | 3% |
Find detailed information on GST compensation rates on goods here: Goods & Service Tax, CBIC, Government of India :: GST Goods and Services Rates
ITC on Compensation Cess: Rules and Usage
One of the key aspects of compensation cess is its treatment under the Input Tax Credit (ITC) mechanism. Businesses can claim ITC on the cess paid for inputs; however, its utilization is restricted solely to offsetting the cess liability on output supplies.
Distribution of Compensation Cess Among States
Funds collected through compensation cess are pooled by the central government and distributed to states based on their shortfalls. The calculation considers:
- The revenue growth promised (14% annually).
- The actual revenue collected post-GST.
If the cess collection falls short of requirements, the central government borrows funds to compensate states, as seen during the pandemic.
Emerging Conversations on Compensation Cess
Compensation cess was meant to be a temporary measure, with the original plan being that it would phase out after five years in June 2022. In the 45th GST Council Meeting, this period was extended up to March 2026. However, as we approach the end of this period, the discussion around the cess’s extension or termination has gained momentum again. Recently, there have been ongoing deliberations within the GST Council and the Group of Ministers (GoM) regarding whether the cess should continue beyond its original tenure. While the initial proposal was to wind down the cess after five years, some states, especially those still facing fiscal challenges, argue that it should remain in place until their revenue positions improve.
In fact, during the 55th GST Council meeting, the GoM presented its report on the state of compensation cess collections and revenue shortfalls. The possibility of extending the cess period or phasing it out gradually is being seriously considered. Some experts believe that the cess should continue, especially for states that are not yet fully self-sustaining under the GST framework. Others argue that the cess should be discontinued as planned, as it could lower the tax burden on consumers and promote economic growth.
Conclusion
GST Compensation Cess has been instrumental in maintaining fiscal stability for states during the GST transition. While it has effectively bridged revenue gaps, its future is clouded by debates on sustainability and fairness. Understanding its application, calculation, and evolving framework is essential for businesses and policymakers alike as India navigates the complexities of GST. If you wish to avoid the complexity in understanding the applicability of compensation cess, opt for an automated GST return filing software like GSTrobo®. Book a demo today!
