Two options offered to states only way out, says Centre on GST compensation

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The Centre remains committed to reimbursing states for the entire shortfall of Rs 2.35 lakh crore in their share of Goods and Services Tax (GST) revenue this financial year – only immediate compensation may not be forthcoming, senior finance ministry officials said on Monday.

“We can and will pay the compensation component arising from Covid-19 also, but only after the cess is extended,” a finance ministry official explained, referring to the cess levied on luxury products and sin goods that goes into the compensation fund and is used to make the payout to the states.

At an August 27 meeting of the GST Council, chaired by Union finance minister Nirmala Sitharaman and comprising state finance ministers, the Centre gave the states two options — either borrow the compensation amount arising from implementation of GST (Rs 97,000 crore) or the entire shortfall (Rs 2.35 lakh crore). If they exercise the first option, the interest and principal amount will come from the cess levied on products such as liquor, cigarettes, aerated water and automobiles. In the second option, the states will have to bear the interest burden in the second case.

Some states have opposed the proposals, and West Bengal finance minister Amit Mitra said on Monday that “state governments are not in a position to borrow any money from the market”, while lamenting that the “Centre is imposing something on states without any proper consultation”.

The finance ministry official cited above explained that the Rs 97,000 crore was the amount that needs to be paid immediately under the law – “within the transition period”.

“Option 1 is what can be immediately borrowed and taken. That is the hardwired compensation gap that will have to be paid under the Act, but in letter and spirit we want to give all the compensation that has to be paid to the states,” the official said. “The compensation arising from a shortfall because of Covid-19 will also have to be paid — only that will have to wait till the cess gets extended.”

Some of the states have since demanded that the Centre borrow the money, but the official said this wasn’t a good idea because it would harden yields in the bond market, and make life tough for private-sector borrowers or even states trying to borrow money for other needs.

The idea, this person added, was for all states to borrow at the same rate through a special window of the Reserve Bank of India (RBI).

On August 29, the Centre detailed the options in a written communication to the states. Several states said they were not happy with the options and would not abide by them. On September 1, the expenditure and revenue secretaries met virtually with state finance secretaries to explain how the options would work.

“All their doubts have been answered,” the finance ministry official said. “Now, we have to see how they respond.”

The official also said too much was being made out of finance minister Nirmala Sitharaman’s comment on the compensation crisis being caused by “an Act of God”.

This is a “force majeure” this person added. “And instead of using the technical term, the minister used the common term. “Force majeure is an event or effect that can be neither anticipated nor controlled, freeing a party to a contract from a liability or obligation.”

The Covid-19 pandemic and the subsequent 68-day hard lockdown has taken a heavy toll on the economy, causing a 23.9% contraction in the quarter ended June 30.

Commenting on the economy, this person cited above said the ministry wasn’t speculating about when it will return to pre-pandemic levels, but is instead focused on “keeping all options open” to support it, especially “industry sectors that have been badly hit”.

The officials cited in the first instance added that while they have to, at some point, sit down and figure out the exact hit to revenue on account of the Covid-19 pandemic, they have not done so thus far.

Still, there are signs of people and companies restarting work, and the rural sector, both agricultural and non-agricultural doing well, the first official said.

The ministry isn’t worried about the fiscal deficit or rating agencies, the official added, but on what the economy needs. As for a second stimulus, the pandemic is still growing, and a vaccine is yet to be developed, the official said, suggesting that the timing is important – but “all options are open”.

West Bengal finance minister Mitra stressed that the payment options before the states were not feasible. “The discussion about the option never happened in the five-hour long meeting as the matter was placed before the [GST] Council only at the last moment. Why, five-hour long meeting when you are determined to give two options at the end,” he said.

“There is no intimation when the Council will discuss this matter. But, there is only one logical and feasible option — the Centre must borrow the entire money and the debt is serviced through the amount raised by the compensation cess. Honourable chief minister [Mamata Banerjee] has already written a letter to the Centre in this regard,” he added.

Banerjee on September 2 wrote a letter to Prime Minister Narendra Modi saying that she was “deeply anguished” by the GST imbroglio which was violating the very premise of federalism. In the letter reviewed by HT, she wrote: “The Centre is duty bound to give compensation to states.”

Kerala finance minister Thomas Isaac wrote in a tweet, “FMs of Punjab, Delhi, W Bengal, Chhattisgarh,Telangana and Kerala agreed to reject the Centre’s options on GST compensation .Our option: Central Govt to borrow entire compensation due regardless of acts of gods, humans or nature, to be paid back by extending the period of Cess.”

An official in a Bharatiya Janata Party (BJP)-ruled state said on condition of anonymity that most of the states were opposed to the Centre’s move, which would put an immense fiscal burden on them.

Experts said the matter needs to be resolved speedily. ”Businesses would appreciate if the Centre and the states discuss and resolve the issue of compensation cess as it is not only a fiscal matter, but one that impacts businesses that have to charge, recover and deposit the cess. The situation is admittedly one where the finances of both the Centre and the states are stressed,” said MS Mani, a partner at consulting firm Deloitte India.

An indirect tax consultant, who asked not to be named, said it was the duty of the Centre to pay full compensation to states, noting that when the GST regime came into place in 2017, there was no argument that revenue loss from an Act of God wouldn’t be covered. “And, if it is an Act of God for the Centre, it is also an Act of God for the states. God for both is the same. Hence, the Centre should follow the spirit of the federalism and GST law and take a loan for states that will be serviced by compensation cess,” the consultant said.