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Can GST Council borrow from market as compensation cess collections fall?

Earlier, there was an impression that states would be compensated for the losses they bore in full, for a period of five years from the date of GST roll out.  The losses would be incurred if states' revenues didn't grow by 14 per cent under the GST regime, on the base year of 2015-16.

However, that was not the legal position. Later, it was made clear that the states would get their dues on this front only from Compensation Cess collections. 

A finance ministry official explains, "The law is very clear. It says that for the purpose of paying compensation, a compensation cess will be introduced. And it is from that cess that compensation will be paid (to the states). If the cess collections do not add up to the required amount, the law does not say that states can take it from central GST…it does not say that the Government of India will pay from its pocket.”

clause 18 of the Constitution amendment Act for GST states, "Parliament shall...on recommendation of the GST Council provide for compensation to the States for loss of revenue arising on account for implementation of the GST for a period of five years."

After that Act, Goods and Services Tax (Compensation to States) Act was passed by Parliament which states that the compensation would be payable to the states from the Goods and Services Tax Compensation Fund. 

Till 2018-19, compensation was not an issue because collections from the cess were more than the states' dues. However, the issue arose in 2019-20 and is likely to worsen in 2020-21.

Compensation cess, levied on coal, pan masala, aerated drinks, motor vehicles exceeding 1,200 cc and with a length exceeding 4,000 mm, and cigarettes, could yield just Rs 95,551 crore in 2019-20 against Rs 98,327 pegged in the Revised Estimates (RE) and Rs 1.09 trillion in the Budget Estimates (BE).

The Centre has not cleared GST compensation to states for the whole of 2019-20 so far. 

A week ahead of the previous GST Council meeting, held on June 12, the Centre had released compensation of Rs 36,400 crore to states for three months to February 2020. For this purpose, the Centre used unutilised integrated GST (IGST) collections. 

The GST compensation of Rs 1.15 trillion for April-November 2019 was released earlier, the government said. For a part of this, the Centre used unutilised funds in compensation cess for the year 2017-18.

In fact, the situation of compensation cess collections is likely to aggravate this financial year. The Centre could collect just Rs 990 crore from the cess in April, 2020-21, almost one-ninth of Rs 8,874 crore a year ago, according to figures released by the Controller General of Accounts.

In fact, the slowing economy is a double whammy for states. It slows down their collections, and when they look forward to higher compensation, they find the kitty under that head is quite small. 

As the situation of compensation cess had started deteriorating earlier as well, the GST Council deliberated for a while on the idea of going for market borrowings at its meeting in March. 

Finance minister Nirmala Sitharaman said she would have to get opinion on various legal issues, such as who would guarantee the borrowing, how would it be repaid, impact on the Fiscal Responsibility and Budget Management (FRBM) Act, and such like.

The Council again discussed the matter in its June meeting but deferred it to the next meeting. 

The issue on hand is whether GST Council can borrow from the market since it is a body of union and state finance ministers. 

Pradeep Kumar Jain, managing partner at Singhania & Co LLP, said though the GST Council is a constitutional body, its function is to make recommendations to the union and state governments on issues related to GST. 

"Unlike other statutory bodies (such as Sebi, electricity regulatory authority etc), it cannot hold property or exercise borrowing powers, so it can't borrow," he said.

Kapil Rana, founder and chairman of HostBooks Ltd, also said the Council is not an organisation that can borrow money and distribute the compensation deficits to states. 

Alternatively, Jain said the Council can recommend monetising future revenue just like reverse mortgage or lease rent discounting. "Here, States can borrow on the basis of their GST collection which can be paid later from revenue," he said.

The Centre can also borrow or guarantee the borrowing. A better option is for states to borrow on the Centre's guarantee, he said. 

But what happens if the states default? The liability would devolve on to the Centre. To this query, Jain said,"Certainly it will be the responsibility of respective states to repay. "Since it is discounting its future revenue, there is a lower chance for default. An agreement can be executed between the stakeholders," he said. 

Rana said the Centre can establish an SPV or can use GSTNewtork. "Using GSTN as an agency to monitor the distribution of deficit will help in many ways like curtailment or extension of the GST compensation collection," he said. 

He said the Centre has better avenues to borrow money and has a bigger revenue budget to manage the deficit in overall balance sheet than states. 

Earlier, Kerala finance minister Thomas Isaac told Business Standard that his state had proposed in the June 12 meeting that the GST Council be allowed to borrow and extend the compensation cess by another year or two and repay. 

He said while Bihar deputy chief minister Sushil Kumar Modi was forthcoming about it, Bharatiya Janata Party-ruled states were mostly lukewarm to the proposal and pressed for a legal opinion on the matter. 

He said the BJP-ruled states wanted to understand the legality. "Some raised the issue that the GST Council was not a sovereign body, and cannot provide guarantee. But then, the Centre will guarantee, so what is the problem," he said.

Isaac said he did not want the Centre to borrow as it would impact its fiscal position. 

"Borrowing by the GST Council will not affect the Centre’s fiscal position. With Covid, the need for compensation has significantly increased whereas it is clear that there is a crisis with respect to the compensation cess collection. A solution must be arrived at the earliest," he said.
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