Is the Central Government Bound To Pay GST Compensation To The States?

Rabindra Kumar Mitra
19 Sep 2020 8:45 AM GMT
Is the Central Government Bound To Pay GST Compensation To The States?
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The decision of the Central Government to not pay Goods and services tax compensation to the States have met with protests. The States have accused the Centre of evading its "constitutional and moral" responsibility, while the Centre has cited insufficient tax collection to defend its austerity. The question that arises here is: Is the Central Government legally bound to pay Goods and services tax compensation ('GST') compensation to the States?

The answer lies within the legal framework of GST – The Constitution (One Hundred and First Amendment) Act, 2016, and the GST (Compensation to States) Act, 2017.

But first, a brief introduction to the concept of GST Compensation. GST was introduced to unify the indirect tax system in India by subsuming all indirect taxes levied by the central and the State Governments. However, it received a cold welcome from the States since it required them to surrender their constitutional autonomy to levy taxes like VAT, sales tax etc.[1] Also, with the point of taxation shifting from manufacturing to consumption, the manufacturing States were facing revenue losses under GST.

To incentivize the States, the Centre offered them the proverbial 'carrot': The States were assured that any shortfall in their revenue due to implementation of GST would be compensated for a transition period of five years. It was only after this assurance that the states agreed to surrender their powers of taxation to GST.[2] But, now that the Centre has reneged on its promise, can the States enforce it?

To ascertain this, we first look at Section 18 of the Constitution (One Hundred and First Amendment) Act, 2016 - the amendment that introduced GST in India.

Section 18 of the Amendment Act reads: "Parliament shall, by law, on the recommendation of the goods and services tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax for a period of five years."

A bare perusal of the Section would reveal that, under the Amendment Act, the Parliament is bound to provide compensation to the States for loss of revenue. The mandatory nature of this obligation is apparent from the use of the term "shall".

But an interesting point to note here is that although section 18 is part of the Amendment Act, it does not alter any article of the Constitution. So, what is the legal authority of a clause of an Amendment Act that is not reflected in the Constitution?

Now, there are two methods of amending the Constitution: (i) altering the text of the Constitution by adding, deleting or substituting words, or (ii) enacting a new article or section that becomes part of the Constitution without effecting any change therein. The Indian Constitution is amenable to both these methods.[3]

It is established that as soon as the procedure for amendment laid down in Article 368 is fulfilled, the Constitution automatically stands amended as per the terms of the Bill. There is no stipulation in Article 368 of any other part of the Constitution that a Bill must always alter the text of the Constitution in order to be effective. This follows the principle that every part of the statute must be regarded as material and given effect to and no part should be rejected as superfluous or decorative.[4]

The Allahabad High Court in Purshottam Lal Sayal vs. Prem Shanker[5] held that Article 368 does not enjoin that an amendment must alter the text of any existing provision to effective. The Court observed that an amendment of an existing law is "contained in and flows from the Amending Act itself, and not from the consequent alteration of the text which is a purely ministerial Act. But every provision, of the amending Act is effective, including those provisions which cannot grammatically or idiomatically be filled into the text of the parent Constitution, like the amending articles in the American Constitution".

Further, in Shantilal Ambalal Mehta[6] and Shripatrao Dajisaheb Ghatge,[7] the Bombay High Court had enforced Section 58 of the Constitution (42nd Amendment) Act, 1976, which was not reflected in the Constitution.

In light of the precedents, Section 18 of the Amendment Act is an integral part of the Constitution and can be effectively enforced against the Centre.

Now, let us look at the cynosure in this conundrum – the GST (Compensation to States) Act, 2017; a statute enacted in furtherance of Section 18 of the 101st Amendment Act and now invoked by the Centre to not pay compensation!

The aim of the GST (Compensation to States) Act, 2017, ('Compensation Act'), as canvassed in its Preamble, is to "provide for compensation to the States for the loss of revenue arising on account of implementation of the GST".[8] Section 7 of the Act, read with Section 3, stipulate that if the annual revenue growth of any State is less than 14%, then the difference between the actual revenue and projected revenue would be given to the State as compensation.

The source of such huge compensation to the States is a Cess levied on certain luxury and sin goods called GST Compensation Cess.[9] This cess is accumulated in a non-lapsable fund called the GST Compensation Fund and the compensation is paid out of this Fund.[10]

The Centre, through a policy paper by the Finance Ministry,[11] has contended that by virtue of Section 10(2), "all amounts payable to the States … shall be paid out of the Fund." Therefore, in case the amount present in the GST Compensation Fund is insufficient, the Centre shall have no obligation to compensate the States by tapping into the Consolidated Fund of India or any other sources of funds.

This argument is incorrect. Firstly, Section 10 (2) does not bar the Centre from accessing other sources of funds to compensate the States. It merely states that all amounts payable to the States shall be out of the Compensation Fund.

Secondly, as per Section 10 (1), the Compensation Fund would comprise of not only the cess amount but also "such other amounts as may be recommended by the Council".

Section 10 (1) reads: "The proceeds of the cess leviable under section 8 and such other amounts as may be recommended by the Council, shall be credited to a non-lapsable Fund known as the Goods and Services Tax Compensation Fund, which shall form part of the public account of India and shall be utilised for purposes specified in the said section".

This provision demolishes the Centre's arguments since under the Act, the GST Council has the power to recommend the Centre to tap into other sources of fund to make up a shortfall in the Fund. It is also noteworthy to mention the Minutes of the 10th GST Council Meeting dated February 18, 2017,[12] wherein the States were assured that it was "implied" that the "Central government could raise resources by other means for compensation and this could then be recouped by the continuation of the cess for more than five years".[13]

But how is it the onus of the Central Government when the Act empowers the GST Council? This is because the Centre, whose vote has a weightage of one-third of the total votes cast, enjoys a de-facto veto power in the Council sin and can unilaterally block a proposal moved before the Council, even if majority of the States assent to it.[14]

It is clear that the Centre has promised to compensate the States and such promise finds its place in the Constitution by virtue of the 101st Amendment Act, 2016. Invoking the defence of shortfall in the compensation Fund is futile, since the Compensation Act, 2017, allows the Centre, on the recommendation of the GST Council, to tap into other sources of funds.

It is to be seen now whether the Central Government chooses to uphold the spirit of federalism, or persists in evading its responsibility by evoking contract law principles of force majeure.

Views are personal only.

[1] Article 246, read with List II of the Seventh Schedule of the Constitution

[2], With the Centre refusing to pay compensation to states, is GST nearing an end? <>

[3] Purshottam Lal Sayal vs. Prem Shanker, AIR 1966 All 377; See: Kesavananda Bharati & Ors. vs. State of Kerala & Anr., AIR 1973 SC 1461 at paragraph no. 1483; A.V. Dicey, The Law of the Constitution, 10th Ed. at page no. 129.

[4] Taylor vs. Oldham Corporation, 4 Ch D 395 (410).

[5] AIR 1966 All 377

[6] Shantilal Ambalal Mehta vs. M.A. Rangaswamy, (1977) 79 BomLR 633

[7] Shripatrao Dajisaheb Ghatge vs. The State of Maharashtra, AIR 1977 Bom 384

[8] Preamble, GST (Compensation to States) Act, 2017

[9] Section 8 (1), GST (Compensation to States) Act, 2017

[10] Section 10 (2), GST (Compensation to States) Act, 2017



[13] Excerpt from the Minutes of Meeting:

"6.3. The Hon'ble Minister from Telangana stated that the Compensation Law should provide that if money fell short in the Compensation Fund, it could be raised from other sources. The Secretary stated that Section 8(1) of the draft Compensation Law provided that cess could be collected for a period of five years or such period as may be prescribed on the recommendation of the Council. He stated that this implied that the Central Government could raise resources by other means for compensation and this could be then recouped by continuation of cess beyond five years."

[14] Article 279-A

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