{"id":7078702,"date":"2026-10-07T00:13:17","date_gmt":"2026-10-07T00:13:17","guid":{"rendered":"https:\/\/fivemor.com\/?p=7078702"},"modified":"2026-10-07T00:13:17","modified_gmt":"2026-10-07T00:13:17","slug":"breaking-down-the-gst-compensation-dispute","status":"publish","type":"post","link":"https:\/\/fivemor.com\/?p=7078702","title":{"rendered":"Breaking down the GST Compensation dispute"},"content":{"rendered":"


\n<\/p>\n

\n
<\/a><\/div>\n

Yesterday,
\nThomas Issac, the Finance Minister of Kerala, stated that<\/a>
\na bunch of State Governments were considering whether they should approach the
\nSupreme Court \u2013 against the Central Government\u2019s decision to deny them GST
\nCompensation. But, within 24 hours of this development, the Centre agreed to
\nthe demand of the State Governments, and stated it would borrow funds from the
\nRBI \u2013 to compensate the State Governments for their revenue losses. <\/span><\/p>\n

In this
\npost, we shall discuss what this controversy is all about. We shall also
\ndiscuss the constitutional structure of the GST \u2013 which shall explain why
\nStates such as Kerala had to consider approaching the Supreme Court against the
\nstance that was taken by the Centre. <\/span><\/p>\n

The
\nconstitutional structure of the GST<\/span><\/i><\/b><\/p>\n

Since the
\nlast week of August, a tussle has been brewing between the Centre and multiple
\nState Governments, regarding the scope and extent of the Centre\u2019s obligation to
\ncompensate the State Governments \u2013 for the revenue loss suffered by them after
\nthe implementation of the GST. Before getting into the specifics of the
\ncompensation controversy, it is important to revisit the constitutional
\nstructure of the GST, and the change it brought about in India\u2019s indirect
\ntaxation framework. <\/span><\/p>\n

The constitutional
\nframework for the GST was laid down through the 101st<\/sup>
\nConstitutional Amendment<\/a> (a.k.a the \u2018GST Constitutional Amendment\u2019). This Constitutional
\nAmendment inserted Article 246A \u2013 which conferred the Central and State
\nGovernments with the power to jointly levy the GST. Prior to the GST
\nConstitutional Amendment, the Centre and the States did not have the power to \u00a0<\/span>levy the same indirect tax. They only had the
\nlegislative power to exclusively levy specific indirect taxes. For instance,
\nwhile the Centre had the exclusive power to levy indirect taxes such as excise
\nduty, the States could levy entry tax, VAT etc. <\/span><\/p>\n

As the
\nGST is a single tax that replaces all other indirect taxes (like excise duty,
\nentry tax, VAT etc) \u2013 it is levied jointly by the Centre and the States, who
\nsplit the revenue. After the passing of the GST Constitutional Amendment, the Centre
\nand the States have lost the legislative power to independently levy indirect
\ntaxes. They now levy the GST jointly, as a common indirect tax. <\/span><\/p>\n

As the
\nCentre and the States were now going to levy the same tax, a GST Council was set-up
\nunder Article 279A of the Constitution \u2013 to facilitate collective
\ndecision-making between the Centre and the States. The GST Council is headed by
\nthe Union Finance Minister, and also consists of the Union Minister of State
\nfor Finance, and the Finance Minister of each State Government. <\/span><\/p>\n

Article
\n279A of the Constitution confers the GST Council with the power to make
\ndecisions on all matters relating to GST implementation. Such decisions are
\ntaken through a voting mechanism, where the Centre effectively has a veto over
\nany decision that the GST Council may take. To simplify \u2013 even if all State
\nGovernments agree to take a specific decision relating to the GST, it shall fail
\nto pass muster if the Centre doesn\u2019t agree, and exercises its veto. <\/span><\/p>\n

On the other
\nhand, if the Centre wishes to successfully put a proposal before the Council,
\nit shall require the support of 21 State Finance Ministers \u2013 who represent
\ntheir State Government. The decision shall be binding even on those State
\nGovernments who vote against the proposal of the Centre. The voting mechanism
\nof the GST Council is hence designed in such a way that tax policies can be
\nimposed even on the dissenting State Governments. Even if the voting mechanism
\nis not resorted to, all the decisions are taken through common consensus. <\/span><\/p>\n

This
\nleads to a situation where the States have lost the power to independently
\nframe their indirect tax policy, and are bound by the decisions of the GST
\nCouncil. GST has hence significantly diluted the fiscal autonomy that States
\npreviously had \u2013 which they could tap in to generate additional sources of
\nrevenue. States are now also more dependent on the Centre for their revenue needs
\n– as every decision of the GST Council can go through only with the Centre\u2019s
\nassent. <\/span><\/p>\n

The obligation
\nto compensate States for revenue shortfall <\/span><\/i><\/b><\/p>\n

As the fiscal
\nautonomy of the State Governments has been diluted by the GST, they now have lesser
\nscope for raising additional sources of revenue. The State Governments have always
\nfeared that GST shall reduce their overall revenue growth. Hence, while the GST
\nwas being discussed and negotiated, the State Governments consistently demanded
\nthat the Centre should enact a mechanism to compensate the State Governments
\nfor potential revenue losses \u2013 that they may suffer after the GST is
\nimplemented. <\/span><\/p>\n

The
\nCentre acceded to this demand while the GST was being negotiated. As Thomas
\nIssac, the Finance Minister of Kerala, pointed
\nout<\/a>, the State Governments assented to the GST since the Centre had agreed to
\nenact a legal framework to compensate the State Governments for the revenue losses
\nthat they may suffer. To this end, Section 18 of the GST Constitutional
\nAmendment states that Parliament shall enact a law to provide for compensation
\nto the State Governments for revenue losses that arise for the first 5 years after
\nthe implementation of the GST (i.e. from July 2017 \u2013 July 2022). <\/span><\/p>\n

(It is interesting
\nto note here that although Section 18 is part of a Constitutional Amendment
\nAct, it does not amend or insert any provision into the Constitution.)<\/span><\/i><\/p>\n

In
\nfurtherance of this mandate, Parliament enacted the GST
\n(Compensation to States) Act, 2017<\/a> (\u2018Compensation Act\u2019) \u2013 which laid down a
\nframework for compensating the States. Under the Compensation Act, if the annual
\nrevenue growth of a State is less than 14%, it shall be compensated for the
\nshortfall in revenue. For instance, if the annual revenue growth of Maharashtra
\nis 10%, it shall be compensated for the balance 4% – which is the shortfall. The
\nstatute also levies a GST Compensation Cess. The funds collected through this Cess
\nare transferred to a specified fund named the GST Compensation Fund. <\/span><\/p>\n

The
\nproceeds of the GST Compensation Fund are then utilized for compensating the
\nState Governments, based on their annual revenue shortfall. <\/span><\/p>\n

The GST compensation
\ncontroversy<\/span><\/i><\/b><\/p>\n

Now, as
\nGST collections significantly fell during the lockdown, the amount present in the
\nGST Compensation Fund is insufficient to meet the total revenue shortfall of
\nthe State Governments. In the end of August, the Central Government contended
\nthat the Covid-19 pandemic was an \u2018Act of God\u2019, and that as the amount present
\nin the GST Compensation Fund was insufficient, it would not be able to fully
\ncompensate the State Governments for their revenue loss. The Centre also
\ncontended that under the GST compensation framework, it had no obligation to
\ntap funds from other resources to compensate the States \u2013 in case there was a
\nshortfall in the GST Compensation Fund. <\/span><\/p>\n

The
\nCentre stated that it would not borrow any further sum of money to compensate
\nthe States \u2013 and presented the States with two options through which they could
\nborrow the money themselves. States such as Kerala and Punjab rejected this
\nproposal. They stated that the Centre was in a better position to borrow funds to
\ncompensate the State Governments, and the mandate to provide compensation
\ncannot be sidestepped. After negotiations that took place in meetings of the
\nGST Council, 21 States have accepted the terms of the Centre, and had agreed to
\nborrow funds for financing their revenue shortfall. <\/span><\/p>\n

But,
\nother States such as Kerala, Punjab, West Bengal and Telangana had refused to
\naccede to the Centre\u2019s terms. They continued to hold the view that the Centre
\nis breaching its legal obligation by refusing to fully compensate the States.
\nAs the Centre had repeatedly refused to accept the demands made by these
\nStates, Thomas Issac (Finance Minister of Kerala) had stated that some of these
\nState Governments may petition the Supreme Court for a resolution of this
\ndispute. <\/span><\/p>\n

Within 24
\nhours from this announcement, the Central Government completely changed its
\nstance. The Centre has
\nagreed to borrow the money<\/a> required to compensate the States from the RBI. The
\namount borrowed from the RBI will be transferred to the States in the form of back-to-back
\nloans. Hence, the Centre shall now directly fund the States for their revenue
\nshortfall, and the States shall not have to borrow the money from the RBI, or
\nthe open market. <\/span><\/p>\n

The State
\nof Kerala has already stated that it welcomes the Centre\u2019s decision to borrow
\ndirectly from the RBI. Other States are also likely to follow suit, as the Centre\u2019s
\ndecision to borrow the money themselves is in tune with what the States had
\ndemanded. This is likely to resolve the stalemate, and State Governments may
\nnow refrain from taking this issue to the Supreme Court. A resolution of this
\nstalemate is significant \u2013 as the promise of full compensation for revenue losses
\nuntil July 2022 was one of the founding assurances which convinced State
\nGovernments to give assent to the GST Constitutional Amendment. <\/span><\/p>\n

Multiple pitfalls<\/span><\/i><\/b><\/p>\n

At the
\nsame time, this compensation controversy has highlighted multiple pitfalls of
\nthe GST constitutional framework, some of which are as follows:<\/span><\/p>\n