GST Council Meeting: Some States To Push For Extension Of GST Compensation Period 

A clutch of states, governed by parties other than the ruling Bharatiya Janata Party, intend to come together to push for a longer period of compensation under the Goods and Services Tax regime.

The GST Constitutional amendment assured states of compensation for loss of revenue for five years (2017-2022), as state levies were subsumed under the common national tax. A subsequent law mandated a 14% compounded growth in states’ GST revenue every year till 2022. A cess was imposed on sin goods to fund this revenue assurance.

Some states, however, are arguing that the period of compensation needs to be extended.

In a May 23 letter, Ashok Gehlot, chief minister of Rajasthan, said he has been “raising the issue of extending the GST compensation period from 2022 to 2027...” Gehlot called on states run by the Indian National Congress and “like-minded political parties” to discuss the issues to be raised in the GST Council meeting on Friday. BloombergQuint has reviewed a copy of the letter which was addressed to another state chief minister.

This is first meeting of the council in nearly seven months.

The extension of the five-year revenue guarantee must be considered, said TS Singh Deo, finance minister of Chhattisgarh.

“With the economy slowing down considerably, growth is not there. Any pick-up in growth is on a negative base of last year. This is the time for the central government to step in. If it (GST) is not working, then you have a common rate of taxes in the country and you disband the GST council and the idea of cess for protected income,” Deo told BloombergQuint.

The finance ministers of West Bengal, Jharkhand, Punjab, Kerala, Rajasthan, Tamil Nadu and Chhattisgarh met on Wednesday, he said, and deliberated on issues such as extension of the compensation period among others ahead of the upcoming meeting.

“Today, GST is being held together by a loose thread called revenue guarantee and that thread is about to snap in July 2022. So the choice is clear, if you want GST, you tighten that thread again. There has to be an effort to rebuild trust between Centre and states,” said Praveen Chakravarty, political economist with the Congress party.

The GST Council will need to discuss the specifics of any such extension, Chakravarty said. “Now, whether it is 14%, whether it is 3 years or 5 years for an extension, those have to be worked out by the GST Council. But, the idea that there has to be a revenue guarantee to hold GST together is very, very clear now.”

He added that the idea of a revenue guarantee is written in the Constitution and that guarantee has to be fulfilled. “It can come from a cess levy, it may come out of the Consolidated Fund of India.”

In the prevailing circumstances, it is necessary to give a certain degree of insurance to the states for the loss of revenue because GST revenue has still not stabilised, M Govinda Rao, economist and member of the 14th Finance Commission, told BloombergQuint.

“The Fifteenth Finance Commission has also assumed there will be some compensation guarantee. They may rework the compensation package and may not give 14% every year. I think it will be useful to provide a certain level of comfort to states by extending compensation period without which it may become difficult to further reform GST.”

Rao pointed out that GST needs more rationalisation in terms of fewer rates, a correction in inverted duty structures and the inclusion of petroleum products. States would need some revenue comfort to agree to such changes, he added.

A separate May 24 letter from Punjab Finance Minister Manpreet Singh Badal to Finance Minister Nirmala Sitharaman also said that GST had failed to deliver on its promises so far. Badal, in his letter, did not demand an extension in the period of compensation but listed a series of steps that can be taken to make GST more effective.

Some of these include:

• Review and harmonise tax rates to eliminate opportunities of evasion and simplify tax credit chain.
• Make GST predictable by strengthening the system of Advance Ruling Authority and preferably issuing detailed guidance notes for uniform implementation.
• Reducing the burden of tax compliance and plugging tax leakages.

“We have about one year before the period of assured compensation is over. Compensation acts as the best binder and thus the remaining period must be used in the most productive manner to overcome all the aberrations and distortions that have crept into GST,” Badal wrote in the letter, a copy of which has been reviewed by BloombergQuint.

A Finance Ministry official, speaking on condition of anonymity, said that some states have been demanding that the period of compensation should be extended by another three-five years. Extension of compensation cess and extending the period of GST compensation are two different matters, the official said.

An extension in the compensation period for states would require a constitutional amendment. Currently the revenue assurance in the Constitution does not prescribe the funding route, i.e.: it makes no mention of how the assured revenue is to be funded, whether by the Consolidated Fund of India or via a cess or any other mechanism.

Compensation Cess For FY22

Separately, the GST Council will on May 28 also take up the matter of estimated shortfall in compensation cess collected in FY22. This is the second year that such a shortfall is arising. Last year, the central government made up the shortfall by extending loans of Rs 1.1 lakh crore to states. It funded only part of the shortfall, arguing the rest was on account of an unprecedented event that it was not liable to recompense.

This year, the central government is looking to borrow about Rs 1.6 lakh crore from the market to compensate states, the government official quoted above said. At present, this will cover for the full estimated shortfall. The government estimates that a compensation of Rs 2.7 lakh crore would be needed this year. Of this, about Rs 1-1.1 lakh crore will likely be collected through the cess imposed, the government official indicated

Any current estimates are subject to change given the prevailing uncertainty in the economy amid the second wave of Covid infections.

In FY21, the central government borrowed 3–5-year funds from the market and passed them on as back-to-back loans to states. A similar mechanism will be followed this year.