The story so far: Just a day ahead of the 46th meeting of the GST Council on December 31, the Finance Ministers of several States had a pre-Budget interaction with the Union Finance Minister and demanded that the GST compensation scheme be extended beyond June 2022, when it is set to expire. Citing the impact of the COVID-19 pandemic on the overall economy and more specifically States’ revenues, the States including Tamil Nadu, Kerala, West Bengal, Rajasthan and Chhattisgarh stressed that while their revenues had been adversely impacted by the introduction of GST, the hit from the pandemic had pushed back any possible rebound in revenue especially at a time when they had been forced to spend substantially more to address the public health emergency and its socio-economic fallout on their residents.

THE GIST

• Ahead of the 46th meeting of the GST Council, Finance Ministers of several States at a pre-Budget interaction with the Union Finance Minister demanded that the GST compensation scheme be extended beyond June 2022. 
• The adoption of GST was made possible by States ceding almost all their powers to impose local-level indirect taxes and agreeing to let the prevailing multiplicity of imposts be subsumed into the GST. This was agreed on the condition that revenue shortfalls arising from the transition to the new indirect taxes regime would be made good from a pooled GST Compensation Fund for a period of five years that is set to end in June 2022. 
• With the finances of most States having been severely hit in the wake of the pandemic, States have been hard pressed to find ways to garner the resources to meet the essential and additional spending necessitated by the public health crisis. 

What is the GST compensation?

The Constitution (One Hundred and First Amendment) Act, 2016, was the law which created the mechanism for levying a common nationwide Goods and Services Tax (GST). The adoption of GST was made possible by States ceding almost all their powers to impose local-level indirect taxes and agreeing to let the prevailing multiplicity of imposts be subsumed into the GST. While States would receive the SGST (State GST) component of the GST, and a share of the IGST (integrated GST), it was agreed that revenue shortfalls arising from the transition to the new indirect taxes regime would be made good from a pooled GST Compensation Fund for a period of five years that is currently set to end in June 2022. This corpus in turn is funded through a compensation cess that is levied on so-called ‘demerit’ goods. The computation of the shortfall is done annually by projecting a revenue assumption based on 14% compounded growth from the base year’s (2015-2016) revenue and calculating the difference between that figure and the actual GST collections in that year.

What is the shortfall for the current fiscal year ending on March 31?

On October 28, the Union government said the Ministry of Finance had released ₹44,000 crore to the States and Union Territories “under the back-to-back loan facility in lieu of GST Compensation”. After taking into account earlier releases amounting to ₹1,15,000 crore, the total amount released in the current financial year as back-to-back loan in-lieu of GST compensation was ₹1,59,000 crore, it added at the time. The Centre clarified that this sum was in addition to normal GST compensation “being released every 2 months out of actual cess collections” that is estimated to exceed ₹1 lakh crore. “The sum total of ₹2.59 lakh crore is expected to exceed the amount of GST compensation accruing in FY 2021-22,” the Union Ministry of Finance said at the time.

It also explained that the decision for the Union government to borrow the ₹1.59 lakh crore and release it to the States and UTs, which had been taken in the 43rd GST Council Meeting held on May 25, 2021, was aimed at bridging the resource gap due to the short release of compensation on account of the amount accruing into the Compensation Fund being inadequate.

Why are several States seeking an extension of the GST compensation sunset timeline?

With the finances of most States having been severely hit in the wake of the pandemic and the economic slowdown that had preceded the outbreak of COVID-19 in early 2020, the State governments have been hard pressed to find ways to garner the resources to meet the essential and additional spending necessitated by the public health crisis.

Tamil Nadu's Finance Minister Palanivel Thiaga Rajan had last week stressed that with the States’ revenues yet to recover, and considering the huge revenue shortfall that was anticipated, it was necessary that the period of GST compensation be extended by at least two years beyond June 2022. He emphasised that at the time of introduction of GST, the States had agreed to forego their fiscal autonomy with an assurance from the Union government that their revenues would be protected. However, over the last five years, there had been a widening gap between the actual revenues realised and the protected revenues guaranteed. While the trend had been visible even before the pandemic, the gap had widened ever since, Mr. Rajan had observed. This view was broadly echoed by other States including Kerala, Rajasthan and Delhi, with most of them seeking an extension for five years.

Can the deadline be extended? If so, how?

The deadline for GST compensation was set in the original legislation and so in order to extend it, the GST Council must first recommend it and the Union government must then move an amendment to the GST law allowing for a new date beyond the June 2022 deadline at which the GST compensation scheme will come to a close.

Interestingly, even now the compensation cess will continue to be levied well beyond the current fiscal year since the borrowings made in lieu of the shortfalls in the compensation fund would need to be met. In September, the GST Council decided to extend the compensation cess period till March 2026 “purely to repay the back-to-back loans taken between 2020-21 and 2021-22”.