Centre Gives States  Two Options To Meet GST Compensation Cess Shortfall
Finance Minister Nirmala Sitharaman in GST Council meeting in North Block through video conference (Source: Finance Ministry)

Centre Gives States Two Options To Meet GST Compensation Cess Shortfall

The government of India has sought the cover of legal language to reduce its GST liability towards states, and while offering them two options on paper has infact narrowed their choice to just one: additional borrowing.

At the end of a five-hour long GST Council meeting today, Finance Minister Nirmala Sitharaman briefed the media to say that states have been offered two options to resolve the issue of compensation cess shortfall under the goods and services tax. This shortfall has been estimated at Rs 2.35 lakh crore in financial year 2020-21, finance ministry officials said in the briefing.

  • Estimated compensation cess owed to states in FY21: Rs 3 lakh crore
  • Estimated compensation cess collection for FY21: Rs 65,000 crore
  • Estimated compensation cess shortfall for FY21: Rs 2.35 lakh crore

OPTION 1

According to the centre, only Rs 97,000 crore of this shortfall is on account of GST implementation. The rest is due to Covid-19, and not provided for under the GST Constitutional Amendment, the finance minister said.

States have been given the option to borrow Rs 97,000 crore from the Reserve Bank of India via a special window, details of which were not forthcoming. But Finance Minister Nirmala Sitharaman did say that the centre has offered to facilitate the mechanism with the RBI so that states can get loans at G-Sec-linked rates.

OPTION 2

The second option offered to the states is to borrow the full shortfall of Rs 2.35 lakh crore.

The centre had earlier relaxed the FRBM borrowing thresholds for states by 0.5% subject to a few conditions. The finance minister has offered to relax those conditions in case states choose to borrow on this account.

The centre is likely to extend the period of compensation cess collection, on advice from the Attorney General, so as recoup the current shortfall in later years. Currently, compensation cess can be levied on select items for a period of five years ending in 2022.

What is yet unclear is whether the centre will assist states picking option 2 to raise funds from the RBI, and whether the centre will extend the compensation cess levy period to recover the entire estimated shortfall of Rs 2.35 lakh crore or just the amount they believe is owed on account of GST implementation - Rs 97,000 crore.


Note: This was subsequently clarified on Aug. 29 by a Finance Ministry
statement.

Implications

In both options it is clear that the states will have to borrow to fund their expenses, whereas a few states had demanded that the centre shoulder the burden of the shortfall.

States demanded centre should borrow from market and repay by extending levy of cess, said V Narayanasamy, chief minister of Puducherry in a public discussion right after the GST Council meeting. The discussion was convened among states governed by the Congress party.

“States didn’t have any other choice but to consider the options laid out by the centre, said Punjab Finance Minister Manpreet Singh Badal in that discussion.

The centre ‘is arm-twisting states by making them borrow, and is not abiding by the Constitution and the GST Compensation Act,” said Chhattisgarh Commercial Tax Minister T.S Singh Deo in that same discussion.

Many BJP-governed states are in agreement with the centre’s actions.

This is an “abrogation” of the GST agreement between centre and states, said M Govinda Rao, economist and member of the 14th Finance Commission. “The states have no bargaining power, they cannot go back (to pre-GST era),” he pointed out in a discussion on BloombergQuint while emphasising the fiscal stress states are already facing. Pending fineprint of the two options, Rao said he expected most states to pick option 2 on account of sharp revenue shortfalls during the pandemic period.

When you go to the RBI and borrow money (it is) basically to keep the yield curve low which implies the RBI will have to inject huge amount of liquidity or additional money supply. Either directly or indirectly there will be monetisation of this part of the deficit and it will have its own implications on the economy as a whole.
M Govinda Rao, Member, 14th Finance Commission

States have no option, agreed Mukesh Butani, managing partner at law firm BMR Legal. But the states too owe a sense of responsibility to raise funding on their own (either backed by the centre) or via boosting growth, Butani said while citing Maharashtra’s recent decision to cut stamp duty rates in order to incentivise real estate transactions. He also pointed to Uttar Pradesh’s recent efforts to invite more investment.

It’s clear that the period of compensation cess would now be increased beyond five years as contemplated at the time of GST implementation, said Pratik Jain, partner at PwC India. But, it’s good to see that the GST Council did not discuss the possibility of immediate rate increase in cess which is not desirable in the current economic environment, he said.

On the two options proposed by the central government, Jain said the one which allows the states to borrow Rs 2.35 lakh crore would be preferable to them, given that the interest on loan would also be funded by compensation cess. "This would obviously mean that the period of cess would be increased more compared to the other option," he said.

Watch the discussion with M Govinda Rao, Mukesh Butani and Prateek jain here.

The 97,000 Crore Twist

At the time of implementation of the GST, the central government had assured states that it will meet any shortfall in their indirect tax revenue, computed at an annual 14% growth rate. The compensation commitment, for a period of five years, is provided for in the Constitutional Amendment Act whereas the 14% rate is provided for in the GST Compensation Act. The latter also provides for the centre to raise funds to meet this shortfall via levy of compensation cess.

Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax for a period of five years.  
The Constitution (One Hundred and First Amendment) Act, 2016  

In the first two years of GST the compensation cess collections were more than owed to states. It is this surplus the centre used to bridge the first shortfall in FY20, albeit with several late payments. This fiscal the shortfall is expected to widen on account of the Covid-19 pandemic and shutdowns. Since April the centre has not paid states any compensation. This has led to considerable friction between states and the centre and the matter was the only agenda point in this 41st GST Council meeting.

Interestingly, the centre has chosen to interpret the constitutional amendment provision, that compensation be provided for “revenue arising on account of implementation of the goods and services tax”, to arrive at the Rs 97,000 crore figure in option 1. The rest of the shortfall is on account of the pandemic, or an “act of god” as the finance minister put it. And hence not the centre’s liability to pay.

Kerala Finance Minister Thomas Isaac questioned this distinction in a social media post after the GST Council meeting.

The states have seven days to respond to the options presented by the centre.

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