GST Compensation Regime: The Covid Reality

[R. Kavipriyan and Pranshu Gupta are 4^th year B.A. LL.B. (Hons.) students at NALSAR University of Law, Hyderabad]

The Compensation Cess Controversy

In the immediate aftermath of the Coronavirus pandemic, the Union Finance Minister announced that the revenue shortfall experienced by the States would not be entirely compensated by the Centre, claiming that the said shortfall is on account of an ‘act of god’ i.e., the pandemic. Subsequently, the Union Government released a Policy Paper titled ‘GST Compensation Options’, highlighting the Centre’s stance per its constitutional obligation to compensate the States for the losses suffered on account of the implementation of the GST. In the said paper, the Union provided two options to the States: first,to borrow Rs. 97,000 crores through a special window facilitated by the Reserve Bank of India, or second, to borrow the entirety of the compensation deficit from the market. This caused significant discontent among the States, many of whom criticised the Union Government for reneging on its promise of compensation. The Union Government has sought refuge in the “loss of revenue to the States arising on account of implementation of the goods and services tax”, mentioned in the Preamble of the Goods and Services Tax (Compensation to States) Act, 2017 (‘Act’), to justify its position. The States on the other hand are arguing, that the primary reason behind their assent to the GST regime, despite suffering considerable apportionment of their fiscal powers, was the Centre’s promise to make good the revenue shortfall. This paper seeks to examine the Union Government’s justification for abdicating its responsibility, as well as the counterarguments made by the States and other agents, and appraise their weight in the legal context.

The Structure of GST Council – Centre as an Uninvited Hegemon

Article 279A(1) of the Constitution establishes the GST Council (‘Council’). Conceived as a joint forum, the Council comprises of representatives from the Union as well as the State Governments. While the holistic representative structure of the Council respects the federal spirit of the Constitution, subsequent provisions under article 279A highlight the undue advantage enjoyed by the Union Government in the Council. Article 279A(9) provides that every decision in the Council shall be made by a majority of three-fourths of the weighted votes. However, the subsequent parts of this provision provide that the Centre shall enjoy a weightage of one-third of the total votes cast, while all the States combined shall enjoy a weightage of two-thirds of the total votes. Therefore, in effect, the Centre enjoys a virtual veto over any decision in the Council. While the States can collectively exercise such a veto as well, such a consensus is difficult to build on most of the issues. Therefore, the decision with regard to GST compensation to the States is effectively a unilateral decision by the Centre, supported by the States ruled by the ruling party at the Centre, leaving the other States aggrieved.

The question then is whether the aggrieved stakeholders in the Council have an effective mechanism for the resolution of their grievances. Article 279A(11) provides for the possibility of a dispute resolution mechanism. However, the provision effectively leaves the details of such a mechanism to the Council’s discretion. Therefore, once again, the hegemonic advantage that the Centre enjoys in the Council may be reflected in the conception as well as the instrumentalisation of the potential dispute resolution mechanism. In the current set up, the Centre has undue leeway to decide on the questions of dispute resolution. In other words, it would be possible for the Centre to disregard and deny the States an opportunity to resolve issues that do not suit its interests.

Act of God – A Tenable Defence?

As observed earlier, the Union Government has claimed the defence of force majeure or ‘act of god’ to abrogate its liability of payment of compensation. In order assess the tenability of this justification, it is essential to delve into the origins and scope of the defence of ‘act of god’. The defence of ‘act of god’, first invoked in the English case of Taylor v. Caldwell, originated in tort law, and subsequently evolved in the law of contracts. Throughout the course of its development, the concept of ‘act of god’ has largely remained relevant in the context of private contracts, wherein the parties are unable to discharge their contractual liabilities due to circumstances beyond their control. In other words, the concept of ‘act of god’, both in its origin and evolution, is restricted to the use between private parties that are subjected to sudden and unexpected economic distress on account of events beyond their control.

The history of the concept naturally invites the question as to whether an elected government can brush off its liabilities using the defence of ‘act of god’. The relationship that an elected government shares with the people of a country is, by no stretch of imagination, contractual and private in nature. The nature of the government’s relationship to its citizenry is one of a social contract – wherein the people waive a part of their rights and vest the responsibility for the protection of their rights and liberties with the government, in  ordinary as well as extraordinary circumstances. To that extent, it can be conclusively claimed that the luxury of the ‘act of god’ defence is simply unavailable to a government that is supposed to protect the interests of the citizens at all times.

Further, even if it is assumed that the Central Government’s obligation of compensation to States is contractual in nature, the face of a contractual obligation becoming economically arduous is not a valid ground to claim the defence of ‘act of god’.  It is uncontested that economic activity has slumbered due to the lockdown, leading to a very low cess collection of Rs. 65,000 crores. Further, the lockdown has also played a role in creating a shortfall of about Rs. 2.35 lakh crores of the total compensation due to the States. However, it is still possible for the Government to discharge its obligation towards the States since it has various other options, such as external borrowings, tapping into the Consolidated Fund of India, etc, to make good of the shortfall. Therefore, the Centre’s claim of the defence of act of god  is legally questionable.

The Contradiction Between the Mission and Purpose

In the Policy Paper, the Union Government maintains that since section 10(2) of the Act mentions that compensation to the States shall be paid out of the Compensation Fund, there is no obligation on the Union Government to tap into other sources, in the event that the proceeds from the compensation cess fall short of the amount to be compensated. This position of the Union Government is in stark contrast to the promise it had made to the States. It was in fact on the promise of compensation made by the Union Government, that many States had agreed to ratify the constitutional amendments for enacting the GST. Accordingly, the Preamble to the Act states that it aims to provide compensation for the losses suffered by the States on account of the implementation of GST. The Act therefore firmly establishes the commitment of the Union towards compensating the States’ losses for a period of five years, until 2022. This provision holds immense importance in the current scenario where we have witnessed a decrease in the percentage of direct taxes shared between Centre and States, diminution in the total divisible tax pool due to increasing imposition of cesses and a reduction in the total tax collection as a result of the pandemic. These factors depict the imminent need for the Centre to honour its commitment to the States.

Furthermore, the Policy Paper itself mentions that the Centre is obligated and committed to making good the losses suffered by the States, while simultaneously claiming the defence of ‘act of god’. Herein lies a huge contradiction on the part of the Union Government. While on the one hand, the Union Government acknowledges its obligation to the States, it claims an unusual defence, uncharacteristic of an elected government, to abrogate that obligation, on the other. Furthermore, while section 10(2) provides for the payment of compensation to the States through the proceeds of the compensation cess deposited in the Compensation Fund, nothing is mentioned in the section about the eventuality of a gap between the collected amount and the amount due to be paid. Nor has the section imposed a limitation such  that the compensation could be paid “only” from the Compensation Fund, and no other sources. In such a scenario, it cannot be automatically concluded, as has been done by the Union Government, that there is no further responsibility to make good the shortfall. It is logically inconsistent to conclude that the natural implication of a shortfall in revenue would be to relieve of the Central Government of its promise. Considering the absence of a provision that deals with a situation such as this, it would only be prudent to read the provisions of the Act in a manner consistent with the intention of the Act, particularly, its Preamble. Such a purposive interpretation would undoubtedly lead to a conclusion that it is ultimately the responsibility of the Union Government to make good the losses suffered by the States even when there is a shortfall in the collection of compensation cess.

Therefore, in the interest of ‘cooperative federalism’ that was envisaged by the Union Government when implementing the GST regime, it is the need of the hour that it stands by its promise to compensate the States, and take the most appropriate course of action, logically, economically and legally. It should also serve as an opportunity for the States to establish a firm stance against the undue advantage enjoyed by the Centre within the GST structure, which is contrary to the enunciations of cooperative federalism.

– R. Kavipriyan and Pranshu Gupta