Goods and Services Tax (GST)

What is Compensation of GST?


From UPSC perspective, the following things are important :

Prelims level : GST Compensation

Mains level : Changes in taxation after GST regime

With Centre-State friction over pending compensation payments under the Goods and Services Tax (GST) taking a new turn in the 41st GST Council to meet, the strain on the finances of states is likely to continue in the near term.

Try this question from CSP 2018:

Q.Consider the following items:

  1. Cereal grains hulled
  2. Chicken eggs cooked
  3. Fish processed and canned
  4. Newspapers containing advertising material

Which of the above items is/are exempt under GST (Goods and Services Tax)?

(a) 1 only

(b) 2 and 3 only

(c) 1, 2 and 4 only

(d) 1, 2, 3 and 4

What is GST?

  • GST, being a consumption-based tax, would result in loss of revenue for manufacturing-heavy states.
  • GST launched in India on 1 July 2017 is a comprehensive indirect tax for the entire country.
  • It is charged at the time of supply and depends on the destination of consumption.
  • For instance, if a good is manufactured in state A but consumed in state B, then the revenue generated through GST collection is credited to the state of consumption (state B) and not to the state of production (state A).

Compensation under GST regime

  • Due to the consumption-based nature of GST, manufacturing states like Gujarat, Haryana, Karnataka, Maharashtra and Tamil Nadu feared a revenue loss.
  • Thus, GST Compensation Cess or GST Cess was introduced by the government to compensate for the possible revenue losses suffered by such manufacturing states.
  • However, under existing rules, this compensation cess will be levied only for the first 5 years of the GST regime – from July 1st, 2017 to July 1st, 2022.
  • Compensation cess is levied on five products considered to be ‘sin’ or luxury as mentioned in the GST (Compensation to States) Act, 2017 and includes items such as- Pan Masala, Tobacco, and Automobiles etc.

Alternatives to prevent losses

  • The input tax credit can help a producer by partially reducing GST liability by only paying the difference between the tax already paid on the raw materials of a particular good and that on the final product.
  • In other words, the taxes paid on purchase (input tax) can be subtracted from the taxes paid on the final product (output tax) to reduce the final GST liability.

Distributing GST compensation

  • The compensation cess payable to states is calculated based on the methodology specified in the GST (Compensation to States) Act, 2017.
  • The compensation fund so collected is released to the states every 2 months.
  • Any unused money from the compensation fund at the end of the transition period shall be distributed between the states and the centre as per any applicable formula.

Significance of GST compensation

  • States no longer possess taxation rights after most taxes, barring those on petroleum, alcohol, and stamp duty were subsumed under GST.
  • GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.
  • Finances of over a dozen states are under severe strain, resulting in delays in salary payments and sharp cuts in capital expenditure outlay amid the pandemic-induced lockdowns and the need to spend on healthcare.


Goods and Services Tax

1 Comment
Newest Most Voted
Inline Feedbacks
View all comments
Dhananjay Rai
Dhananjay Rai
2 years ago

Is the PYQ answer C ?


Join us across Social Media platforms.