GST compensation

Why in news?

• The GST Council meeting held Monday to discuss the compensation of states for the shortfall in GST collections again ended without reaching any consensus.
• The panel, which is the highest decision-making body on indirect taxes, failed to arrive at an agreement on the Centre’s proposal of states borrowing against future GST collections to make up for the shortfall.

Why is the Centre required to compensate states for GST?

• With GST implementation in 2017, the principle of indirect taxation for many goods and services changed from origin-based to destination-based. 
• This means that the ability to tax goods and services and raise revenue shifted from origin states (where the good or service is produced) to destination states (where it is consumed). 
• This change posed a risk of revenue uncertainty for some states and their concern was addressed through constitutional amendments, requiring Parliament to make a law to provide for compensation to states for five years to avoid any revenue loss due to GST.

About the compensation:

• For this purpose, the GST (Compensation to States) Act was enacted in 2017 on the recommendation of the GST Council.
• The Act guarantees all states an annual growth rate of 14 percent in their GST revenue during the period July 2017-June 2022. 
• If a state’s GST revenue grows slower than 14 percent, such ‘loss of revenue’ will be taken care of by the Centre by providing GST compensation grants to the state.
• To provide these grants, the Centre levies a GST compensation cess on certain luxury and sin goods such as cigarettes and tobacco products, pan masala, caffeinated beverages, coal, and certain passenger vehicles.
• The Act requires the Centre to credit this cess revenue into a separate Compensation Fund and all compensation grants to states are required to be paid out of the money available in this Fund.

How much compensation is provided to states?

• For 2018-19, Centre gave Rs 81,141 crore to states as GST compensation. 
•  However, for the year 2019-20, the compensation requirement of states nearly doubled to Rs 1.65 lakh crore.
• This can be attributed to the economic slowdown which resulted in a lower GDP growth and thereby lower growth in tax collections which grew by just 4 percent.
• Subsequently states had to be compensated by the centre. But large parts of the compensation were delayed, almost by an year.

What led to a delay in payment of compensation to states?

• In 2019-20, the delay in payment was observed due to insufficient funds with the Centre for providing compensation to states.
• The sale of goods taxed for the compensation did not provide necessary funds as sales of some of them were affected by the economic slowdown. 
• The shortfall in collections for 2019-20 was met through:
  • Surplus cess collections from previous years
  • Partial cess collections of 2020-21
  • A transfer of Rs 33,412 crore of unsettled GST funds from the Centre to the Compensation Fund.  These unsettled funds are GST collections, generated in 2017-18 from interstate and foreign trade, that have not yet been settled between centre and states.

Scenario in 2020-21

• In the 2020-21 budget, the Centre has estimated a 10 percent growth in nominal GDP.  However, due to the impact of COVID-19 and the lockdown, the actual growth in 2020-21 is likely to be much lower. 
•  In such a scenario, states’ GST revenue would also be much lower than expected, thus leading to a higher compensation requirement. 
• However, the ability of the Centre to pay compensation depends on the cess collections, which are also getting impacted this year.
• Under the GST (Compensation to States) Act, 2017, Centre can provide compensation to states only through the money available in the Compensation Fund.
• Despite a shortfall of money in the Compensation Fund, the Centre is constitutionally obligated to meet states’ compensation requirement for a period of five years.
• Six states Delhi, Gujarat, Karnataka, Maharashtra, Punjab, and Tamil Nadu accounted for 52 percent of the total requirement of compensation for 2019-20. 
• The Centre had in August given two options to the states
  • To borrow either Rs 97,000 crore from a special window facilitated by the RBI or Rs 2.35 lakh crore from the market.
  • It had also proposed extending the compensation cess levied on luxury, demerit and sin goods beyond 2022 to repay the borrowing.
• But most non-BJP ruled states have rejected the demand and asked the centre to borrow the amount instead of the states.

PRELIMS QUESTION

Consider the following statements regarding GST compensation fund:
1.Centre is obligated to pay GST compensation to states for ten years in the event of a short fall in GST collections.
2.GST (Compensation to States) Act 2017  guarantees all states an annual growth rate of 14 percent in their GST revenue, failing which they will be compensated.
Which of the statements given above is/are correct?
(a)1 only
(b)2 only
(c)Both 1 and 2
(d)Neither 1 nor 2

Answer to Prelims Question