With the GST compensation cess set to end in March 2026, the Centre and states are staring at potential revenue losses on high-revenue items such as automobiles, tobacco, and aerated drinks.

Government sources said the loss may be offset if the GST Council agrees to amend the legal cap on GST rates to go beyond the current 40 percent, allowing for a merger of the cess with GST rates once the levy is withdrawn.

The group of ministers (GoM) on compensation cess has reached a broad consensus to merge the levy with GST rates — a key step that will ensure the tax burden on high-revenue goods such as automobiles, tobacco, and aerated drinks remains unchanged even after the cess is phased out.

“The GoM has more or less reached a consensus to merge the cess with the GST rates,” a government source told Moneycontrol.

“After March 2026, the cess cannot continue. So, rates will have to be merged with cess to maintain the same revenue. An amendment will be needed since the current maximum GST rate that can be levied is 40 percent,” a second government source said.

The GST compensation cess — levied over and above the standard 28 percent rate on selected sin and luxury goods — was introduced to compensate states for revenue losses after the rollout of the unified tax in July 2017. With all borrowings under the compensation mechanism expected to be repaid, the cess is set to be discontinued from March 2026.

At present, the highest slab under GST is 28 percent, and the legal ceiling is 40 percent, though it has not been used so far. However, the effective tax outgo on several items is significantly higher due to the compensation cess.

For instance, high-end motor vehicles such as SUVs attract a 22 percent compensation cess in addition to 28 percent GST. Aerated drinks carry a cess of 12 percent. On tobacco and related products, the cess varies depending on the type, particularly for cigarettes, taking the total tax incidence to around 55–60 percent.

While cess is often quoted as an add-on to the GST rate, it is technically calculated either on the taxable value or, in some cases like cigarettes, on quantity.

“Once the cess ends, the Centre and states will no longer be able to use it to increase the tax burden on such goods. But to avoid revenue loss, they will need flexibility. Since the current 40 percent cap will not suffice, a hike in the legal ceiling is necessary,” the source added.

What the law says
The 40 percent cap was introduced through an amendment to the Central GST Act in 2018 but has not been utilised. It refers to the maximum GST rate (combined CGST + SGST or IGST) that can be imposed on any item, excluding the compensation cess.

With the cess ending, the Centre will no longer have the option of a dual structure (GST + cess) to impose a higher tax burden on demerit goods. Raising the legal ceiling will give the GST Council the room to maintain effective tax rates on such items.

“The ceiling needs to be raised not because the current GST rate is under 40 percent but because post-cess, future rates will need to legally go beyond 40 percent to retain current revenue levels,” said a source aware of the development.

While the GoM has reached an internal consensus, the recommendation is yet to be formally submitted to the GST Council, which is chaired by the Union finance minister and comprises state finance ministers. The Council is expected to take up the proposal to amend the law in its upcoming meetings, government sources said.

Source: Money Control