The Goods and Services Tax (Compensation to States) Act, 2017
The Goods and Services Tax (Compensation to States) Act, 2017
1. Background
The Goods and Services Tax (GST) was introduced in India on 1st July 2017 as a major indirect tax reform, subsuming various central and state taxes.
GST led to a significant shift in tax revenue structure for states, as they lost control over individual taxes like VAT, excise duty, and sales tax.
To address the potential loss of revenue for states, especially in the initial years post-GST implementation, the Central Government promised compensation to states for any revenue shortfall.
The compensation was guaranteed for a period of five years from GST implementation.
2. Purpose of the Act
The Goods and Services Tax (Compensation to States) Act, 2017 was enacted to:
Provide a legal framework for compensating states for revenue losses arising out of the implementation of GST.
Define the method of calculating compensation.
Establish the GST Compensation Fund.
Lay down provisions for distribution and utilization of compensation amounts.
Ensure transparency and accountability in compensation payments.
3. Key Provisions of the Act
a) GST Compensation Fund
A GST Compensation Fund is created, which pools all compensation cess collected from the supply of notified goods and services.
The fund is maintained by the Central Government but is meant exclusively for compensating states.
b) Compensation Cess
Certain goods and services are subject to a compensation cess in addition to GST.
This cess is collected to finance the compensation payments to states.
c) Calculation of Compensation
Compensation to each state is calculated based on:
The difference between the state's projected revenue and actual revenue.
The projected revenue is based on a 14% annual growth rate over the base year revenue (2015-16).
Shortfall = Projected Revenue – Actual Revenue.
Compensation = Shortfall amount for a particular state for each year.
Compensation is payable only if the actual revenue is less than the projected revenue.
d) Duration of Compensation
Compensation is guaranteed for five years from 1 July 2017 to 30 June 2022.
After this period, no compensation is payable even if states suffer revenue shortfall.
e) Disbursement and Reporting
The Act mandates quarterly payments to states.
States are required to submit audited accounts to claim compensation.
The Central Government is responsible for timely disbursal from the Compensation Fund.
f) Cess Collection and Utilization
Compensation cess is levied on "luxury" and "sin" goods like tobacco, aerated drinks, and vehicles.
The cess revenue is the main source for the compensation fund.
4. Significance
Provides financial security to states during the transition to GST.
Ensures cooperative federalism by addressing states’ revenue concerns.
Encourages states to embrace GST despite initial revenue uncertainties.
Creates a transparent, rule-based mechanism for compensation rather than ad-hoc grants.
5. Relevant Case Law
While specific landmark Supreme Court judgments on the Goods and Services Tax (Compensation to States) Act, 2017 are limited, the following cases provide important legal context regarding GST and compensation:
a) State of Karnataka v. Union of India (2020)
Karnataka challenged the delay and non-payment of compensation by the Centre.
The Supreme Court upheld the constitutional validity of the Compensation Act.
The court directed the Centre to pay pending compensation dues to states.
Reinforced that compensation to states is a constitutional commitment under Article 279A (GST Council) and relevant Acts.
b) Maharashtra v. Union of India (2019)
Maharashtra filed petitions due to delayed compensation payments.
The court emphasized that states should not suffer due to the Centre’s delay in disbursing funds.
The court urged timely payments, reflecting the binding nature of the compensation scheme.
c) GST Council Decisions
Though not judicial decisions, the GST Council’s resolutions have influenced compensation policy, including extensions, cess rates, and dispute resolution.
Courts have recognized the Council’s role as a constitutional body guiding compensation matters.
6. Constitutional and Legal Basis
The Act is enacted under Article 279A of the Constitution, which created the GST Council.
Article 279A(4) empowers the Council to make recommendations on compensation to states.
The Act complements the Constitution’s vision of cooperative federalism by balancing Centre and state fiscal interests.
7. Challenges and Issues
Delays in compensation payments have strained Centre-State relations.
Some states have argued the 14% growth assumption is unrealistic, especially amid economic slowdowns or the COVID-19 pandemic.
The finite 5-year compensation period has raised concerns about fiscal sustainability post-2022.
Adequacy of compensation cess collections to meet liabilities has been questioned.
8. Conclusion
The Goods and Services Tax (Compensation to States) Act, 2017 is a vital legal mechanism that:
Secures states’ revenue during the major tax reform transition.
Provides a transparent, rule-based compensation system funded by a dedicated cess.
Reinforces cooperative federalism by protecting states' fiscal interests.
Has been upheld by courts as constitutionally valid and binding.
Despite some implementation challenges, the Act has played a critical role in stabilizing state finances post-GST rollout.
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