JUNE 17, 2020

By Dr G Gokul Kishore

IN the 40th meeting of the GST Council held on 12th June, 2020, it has been decided to hold the next meeting in July with the single point agenda of discussing and addressing the issue of shortfall in revenue collections and providing sufficient compensation to States. In this Part-83, let us analyse this issue to explore the possible solutions.

Constitutional basis and guarantee

As per Section 18 of the Constitution (One Hundred and First Amendment) Act, 2016 [GST amendments to the Constitution], Parliament shall, by law, on the recommendations of the GST Council, provide for compensation to the States for loss of revenue arising on account of implementation of GST, for a period of five years. Because of uncertainty as to the revenue collections at the time or in the first few years of implementation of the new tax system, possibility of loss of tax revenue was anticipated. Subsuming a host of levies in GST was not expected to translate into same or more revenue as would have accrued on aggregation of the subsumed levies in the absence of GST. Right from the meetings of the Empowered Committee to the initial meetings of GST Council, one of the major or sole concern of the States expressed and debated was not merely ceding of legislative power to tax sale or entry of goods but of the possible loss of revenue. To prevail upon the States to come on board the landmark tax reform, the Centre had to include in the Constitution itself the guarantee to compensate for such loss of revenue. But for Constitutional guarantee, many States might not have been convinced over any other type of assurance of compensation whether statutory or otherwise.

The compensation, as per the above provision, is to be provided through an enactment of the Parliament and such statute is to be based on the recommendations of the GST Council. The guarantee or protection against shortfall in revenues will be for five years only. Article 279A of the Constitution listing the powers of the GST Council includes the residuary power of "any other matter relating to the goods and services tax, as the Council may decide". Reading Section 18 of the Amendment Act and the newly inserted Article 279A, it is manifest that the GST Council is empowered to consider measures on compensating for loss of revenue on account of implementation of GST.

GST Compensation Cess Act

GST (Compensation to States) Act, 2017 has been enacted to implement Section 18 of the Amendment Act and it seeks to levy compensation cess on supply of goods or services or both for five years or such period as recommended by the GST Council. In terms of Section 7 of GST (Compensation to States) Act, compensation will be payable to any State during the transition period. Transition period has been defined as five years from the transition date and, therefore, such payment obligation will run till June 2022. Compensation payable in a financial year will be the difference between the projected revenue and actual revenue collected by a State. Projected revenue is to be calculated by applying projected growth rate over the base year revenue. As per Section 3, projected growth rate is 14% per annum and 2015-16 will be the base year. Therefore, the revenue collected from subsumed taxes in 2015-16 will be the basis and if, in any of the initial five years of implementation of GST, revenue collection falls short by 14% over such base year revenue, compensation will be payable in respect of the shortfall.

To make the process of compensation real-time one, such amount (compensation) is payable on bi-monthly basis based on provisional figures which will be finalized at the end of the year. If the provisional amount paid is more than what is due, excess amount is required to be refunded by the State to the Central Government for crediting the same in the Compensation Fund. It is of interest to note that Section 10 deals with sharing equally between the Centre and States, the amount remaining unutilized in the Compensation Fund at the end of the transition period. There is no provision to cover the scenario of amount in Compensation Fund falling short of the requirement to bridge the shortfall in collections. Absence of express provision may be because of the presumption that cess rate can be varied when collections are not adequate to compensate the States. The primary presumption appears to be that GST collections will always be buoyant, will always increase at a rate greater than the base year collections of subsumed taxes. Can it be said that the possibility of Compensation Fund being inadequate was not foreseen? The answer is no.

Market borrowing and other options in case of shortfall

States were skeptical and they were justified in entertaining doubts over the assumption of ever-increasing collections under GST. Therefore, issue of compensation dominated the initial meetings of the GST Council. In particular, in the 8th meeting of the GST Council held on 3rd and 4th January, 2017, possible shortfall in collection of compensation cess was discussed. The then Chairman said that the GST Council shall, in such circumstances, decide the mode of raising additional resources including borrowing from the market which could be repaid by collection of cess in the sixth year or further subsequent years.

The Council has, therefore, contemplated borrowing from the market as one of the options and it has further considered the question of how to repay the debt. Period of five years has been provided in the Act for imposition of the levy but it can be extended based on recommendations of the GST Council as per Section 8 and possibly through an amendment, compensation can be paid for the sixth year or subsequent years as may be recommended. Though providing compensation beyond five years seems to have not been considered at the time of enactment, considering the present situation of Covid-19 and its long-term consequences, both - continuation of the levy beyond 2022 for both repayment of debt as well as compensating the States - may appear realistic.

In the past, GST Council has reportedly discussed various options to shore up revenue like moving certain items attracting 5% and 12% rate to next higher bracket, levy of GST on high end education and healthcare sectors, further pruning of exemptions, etc., but there has been no consensus and States have informed that they need to study such proposals. Increasing the rate of cess was also considered but the same will not yield much resource to bridge the shortfall. The Act provides for levy of compensation cess on services also but so far it has not been implemented. Imposing cess on certain services will neither be a prudent exercise as it will multiply the levy nor will it be sufficient to address the gap.

This leaves the GST Council with not too many options except borrowing from the market. It may be in the form of issuance of government securities ranging from treasury bills to bonds. The inevitable consequences will be the impact of such borrowing on public debt position and debt servicing obligations. These may result in additional taxes or increase in rate of other taxes at a later date impacting both the public and the industry. Constrained by such factors, the GST Council may even consider reducing the projected growth rate of 14% but the same may not find acceptance among several States. In the past, North Eastern States had demanded 18% to be reckoned as the projected growth rate and it was eventually settled at 14%.

In the present crisis situation, force majeure may come to the rescue of contractual obligations between private parties or even for statutory compliances as effected through ordinance by the government but the same may not offer any relaxation from the constitutional guarantee of compensating the States.

[The author is an Advocate. Views expressed are personal.]

See Part 82.