GST Compensation Cess: A Comprehensive Guide
07 Jul, 2025
By Online Legal India
Published On 07 Jul 2025
Category GST
The GST Compensation Cess plays an important role in ensuring fair revenue distribution among Indian states after the launch of GST. It is a special levy imposed on specific goods and services. The amount collected is used to compensate states for any loss in revenue caused by GST implementation. In this blog, you will learn everything about the GST Compensation Cess.
GST Compensation Cess is an extra tax collected by the Central Government under the GST (Compensation to States) Act, 2017. It applies to specific goods and services, such as luxury or sin items, and is charged over and above the regular GST rates. The main purpose of this cess is to compensate Indian states for any loss of revenue caused by the shift to the GST system. The money collected through this cess goes into a special fund, which is later distributed to states to ensure stable revenue growth.
Here are the purposes of levying GST Cess:
GST follows a destination-based model. This means the state where goods or services are consumed receives the tax revenue. The supplier’s location does not affect this distribution. States with higher production but lower consumption receive less GST revenue under this model.
Some states produce and supply more goods or services than they consume. These states, such as Gujarat, Maharashtra, or Tamil Nadu, face a fall in revenue after the introduction of GST. Since they supply to other states where consumption occurs, their share in indirect tax collections reduces.
To address the possible revenue loss, the central government introduces a support mechanism. The aim is to ensure that no state earns less than what it collected before GST implementation. This step helps states transition smoothly into the new tax regime.
The Parliament enacts the Goods and Services Tax (Compensation to States) Act, 2017. This law allows the central government to compensate states for a fixed period. The Act defines the revenue protection formula and creates a compensation fund. It sets the base year as 2015–16 and ensures 14% annual revenue growth for states.
As per the Act, the compensation period starts from July 1, 2017, and continues for five years. This period ends on June 30, 2022. The GST Council later extended the collection of cess till March 31, 2026, to repay loans raised to meet earlier compensation dues.
The central government imposes a cess on specific goods and services. This cess applies in addition to the regular GST rates. Goods such as tobacco, aerated drinks, luxury cars, and coal attract this cess. The revenue from this cess goes into a non-lapsable Compensation Fund. The central government uses this fund to compensate states.
Exporters do not bear the burden of GST Compensation Cess. If they pay cess during procurement, they can claim a refund. This rule ensures exports remain tax-free, maintaining their competitiveness in international markets.
Taxpayers who supply specific goods or services such as select luxury or sin categories must collect GST Compensation Cess, except those registered under the composition scheme and exporters. This cess also applies to select imported goods. However, if any exporter pays this cess during business operations, they can later claim a refund. This ensures that exports stay tax-neutral and remain competitive in global markets.
The GST (Compensation to States) Act, 2017 lists certain goods that attract a special cess. This list is updated from time to time. Each good has a specific cess rate. The purpose is to help states recover revenue losses after the GST was introduced.
Below is the list of GST compensation cess rates for goods:
| Goods | GST Compensation Cess |
|---|---|
| Cut tobacco | Rs. 0.14 per unit |
| Unmanufactured tobacco (with lime tube, branded) | Rs. 0.36 per unit |
| Unmanufactured tobacco (without lime tube, branded) | Rs. 0.36 per unit |
| Branded tobacco refuse | Rs. 0.32 per unit |
| Tobacco extracts & essence (branded) | Rs. 0.36 per unit |
| Tobacco extracts & essence (unbranded) | Rs. 0.36 per unit |
| Filter khaini | Rs. 0.56 per unit |
| Jarda scented tobacco | Rs. 0.56 per unit |
| Cheroots & Cigars | 21% or Rs. 4170 per 1000 units (whichever is higher) |
| Cigarillos | 21% or Rs. 4170 per 1000 units (whichever is higher) |
| Cigarettes (≤65mm, non-filter) | 5% + Rs. 2076 per 1000 units |
| Cigarettes (>65mm to 75mm, non-filter) | 5% + Rs. 3668 per 1000 units |
| Filter cigarettes ≤65mm | 5% + Rs. 2076 per 1000 units |
| Filter cigarettes >65mm to 70mm | 5% + Rs. 2747 per 1000 units |
| Filter cigarettes >70mm to 75mm | 5% + Rs. 3668 per 1000 units |
| Cigarettes of tobacco substitutes | Rs. 4006 per 1000 units |
| Cigarillos of tobacco substitutes | 12.5% or Rs. 4006 per 1000 units (whichever is higher) |
| Smoking mixtures for pipes/cigarettes | 290% |
| Branded hookah/gudaku tobacco | Rs. 0.36 per unit |
| Unbranded hookah tobacco/gudaku | Rs. 0.12 per unit |
| Other unbranded water pipe tobacco | Rs. 0.08 per unit |
| Other branded smoking tobacco | Rs. 0.28 per unit |
| Other unbranded smoking tobacco | Rs. 0.08 per unit |
| Homogenised/reconstituted tobacco (branded) | Rs. 0.36 per unit |
| Chewing tobacco (without lime tube) | Rs. 0.56 per unit |
| Chewing tobacco (with lime tube) | Rs. 0.56 per unit |
| Chewing tobacco preparations | Rs. 0.36 per unit |
| Pan masala (gutkha) with tobacco | Rs. 0.61 per unit |
| Other branded goods (excluding gutkha) | Rs. 0.43 per unit |
| Other unbranded goods (excluding gutkha) | Rs. 0.43 per unit |
| Snuff | Rs. 0.36 per unit |
| Snuff preparations | Rs. 0.36 per unit |
| Coal, lignite-based briquettes, similar fuels (excluding jet and peat) | Rs. 400 per tonne |
| Aerated waters | 12% |
| Lemonade | 12% |
| Other carbonated drinks | 12% |
| Motorcycles with engine capacity >350cc | 3% |
| Aircraft and helicopters for personal use | 3% |
| Yachts/pleasure/sports vessels | 3% |
| Passenger vehicles (up to 13 persons incl. driver) | 15% |
| Hybrid cars (≤1500cc, length ≤4000mm) | 15% |
| Petrol/CNG/LPG cars (≤1200cc, length ≤4000mm) | 1% |
| Diesel cars (≤1500cc, length ≤4000mm) | 3% |
| Vehicles (engine ≤1500cc) | 17% |
| Vehicles (engine >1500cc) | 20% |
| SUVs (engine >1500cc, length >4000mm, ground clearance ≥170mm) | 22% |
Input Tax Credit (ITC) under GST helps businesses reduce their tax liability by allowing them to claim credit for the tax paid on purchases. This system supports tax efficiency and avoids tax-on-tax. However, Compensation Cess follows a stricter rule. It is a special tax applied to specific luxury and sin goods. The ITC collected on Compensation Cess cannot be used to pay other GST liabilities like CGST, SGST, or IGST. It can only be used to pay the Compensation Cess on a business's output. This rule ensures the credit is used only for the purpose the cess was introduced.
Compensation Cess is an additional charge collected over and above the regular GST on certain goods and services. It is calculated in a similar way to GST. The cess amount is determined by applying the specified rate to the transaction value, as defined under Section 15 of the CGST Act, 2017. This ensures accurate and consistent tax calculation.
The compensation amount to be distributed to each state is calculated as follows:
Step 1: The process starts by considering the tax revenue earned by each state during the financial year 2016–17 as the base amount.
Step 2: A fixed annual growth rate of 14% is assumed to estimate how much revenue the state would have earned each year if GST had not been introduced. This projected revenue is calculated for a period of five years, as the compensation cess was designed to support states during the five-year transition.
Step 3: To find the compensation amount for each year, the actual GST revenue collected by the state is subtracted from the projected revenue.
Formula: Projected Revenue – Actual Revenue = Compensation Payable
The central government carries out this calculation every two months and releases the due compensation to the states accordingly. If there is any extra money left in the compensation fund after the five years, it is shared between the Centre and the states using a suitable formula.
Conclusion
The GST Compensation Cess is a crucial mechanism designed to support Indian states during the transition to the GST system. It ensures that states do not face revenue losses due to the shift from the previous tax structure. The cess is collected on selected luxury and sin goods and placed into a dedicated fund. The collected fund is utilized to offset any revenue shortfall faced by the states. Though temporary, the cess helps maintain financial balance and stability across the country.
Redirecting to payment page...
