The status of GST reimbursement fees

The story so far: At a meeting with prime ministers last week, Prime Minister Narendra Modi said several non-BJP-ruled states have failed to cut taxes on fuel products, prices of which have risen sharply since March, and urged them to do so in the interest of relief to do people who are exposed to high inflation. Most of the states he was referring to – West Bengal, Tamil Nadu, Maharashtra, Kerala, Telangana, Jharkhand and Andhra Pradesh – bluntly resisted the Prime Minister’s accusation. West Bengal and Tamil Nadu said they had previously reduced their VAT levies. Maharashtra and Kerala pointed to the states’ resource constraints and the center’s outstanding fees. Mamata Banerjee’s government said cutting state levies on petrol and diesel will only be possible if the center settles its outstanding fees of over 97,000 crore, including compensation for the introduction of the Goods and Services Tax (GST).

What is the status of outstanding GST compensation due to states?

The GST regime involved the abolition of several state and central levies to create a simplified corporate tax regime. Since the states had to give up several taxing powers in the process, they were assured that revenue shortfalls would be compensated for five years. Compensation should be calculated by assuming 14% annual growth over 2015-16 revenue from government taxes subsumed in GST and paid from an equalization fund backed by levies on sin and luxuries such as pan masala , tobacco, coal and cars.

Hours after the meeting, to counter these states’ arguments about outstanding fees, the Treasury Department said the outstanding GST indemnity fees to states for 2021-22 totaled 78,704 crore, equivalent to four months of such accruals. This means that the fees for the eight-month period from April 2021 to November 2021 have been transferred to the states. The ministry, which last paid out ₹18,252 crore of GST compensation to states and union territories in March, said it was unable to pay the fees immediately due to “lack” of the compensation fund. “Typically, compensation for 10 months from April to January of any fiscal year is released during that year and compensation for February to March is not released until the next fiscal year. The outstanding amount will also be released as soon as the amount from the assignment accrues in the compensation fund,” the ministry assured.

In addition to the 78,704 crore states are said to be owed for the period December 2021 to March 2022, compensation for the period April to June – the last quarter for which such fees accrue – must also be arranged. ICRA’s chief economist Aditi Nayar has estimated that this could be another ₹60,000 crore, with the total fees to be paid to states being close to ₹1.4 crore.

How much GST compensation has been paid to states so far and when does this levy end?

Since July 2017, when the GST regime came into effect, approximately ₹7.35 lakh crore has been released to the States as GST compensation so far. It had nearly doubled from ₹83,000 crore in 2018-19 to ₹1.65 lakh crore in 2019-20 before the pandemic hit the economy and revenues across the board. The Treasury said £2.78 billion in compensation was released to states for the year 2020-21 itself. As GST and compensation inflows dried up due to the COVID-19 lockdowns, up to ₹1.1 lakhcrore was funded through dedicated market borrowing. Indeed, the Center has borrowed these funds and staggered them throughout the year as back-to-back loans to the States. Similarly, in 2021-22, ₹1.59 lakh crore was raised to pay the states’ compensation fees according to estimated deficits in levy fund collections, and these funds were fully paid out by October, following on from the early reloading of the loans during the financial year was used. At the time, the Treasury had expected total compensation payments for the year to be 2.59 lakh crore, which would exceed the amount of compensation due to states in 2021-22, indicating it was pending Compensation defaults for 2020-21 included.

The collection of the countervailing levy, which was due to end on June 30 this year, has been extended until March 2025/26 in order to use the proceeds to repay the principal and interest on these special loans. Several states, concerned that revenue streams will fall off a cliff once pledged compensation ceases to accrue from July 1, have called on the center to extend the GST compensation period beyond the five-year pledge. However, these demands have so far been stymied by citing the legal provisions that enable GST and are unlikely to prevail.

Do the record GST surveys of the last few months help?

To the extent that states receive a larger share of higher GST revenue, of course. With April and May both posting new highs in GST revenue of 1.42 lakh crore and above 1.67 lakh crore, the adjusted share of the center and states was a robust 1.32 lakh crore and 1, respectively, 36 lakh crore the two month period. However, GST offset levy collections are still not growing as fast as the overall treasury. Giving states some clarity on when outstanding GST compensation fees will be released will help them plan their borrowing for the year, which will be particularly difficult beginning July. While the expected reduction in GST balancing flows from July 2023 could increase government borrowing this year, the timing of the release of the outstanding funds would significantly affect their plans, Ms Nayar noted.

As states are expected to aggressively drive capital spending this year, which is critical to spurring growth, an early release of funds, whether it be the transfer of other tax revenues or GST compensation, would help them plan public infrastructure projects more quickly and to execute.