GST Cess – Rate, Applicability, and Calculation

The GST Compensation Cess is a special tax levied under Section 8 of the Goods and Services Tax (Compensation to States) Act, 2017. It is primarily imposed on the intra-state and inter-state supply of certain goods, particularly luxury items, sin goods, and tobacco products, to compensate states for any revenue loss resulting from the implementation of GST. Following the recent GST reforms effective September 22, 2025, the cess has been largely eliminated for most goods, with the exception of tobacco and related products, which continue to attract the compensation cess. This article explains the current applicability, rates, and calculation methodology for the GST Compensation Cess under the updated rules.

Key Takeaways

The highly anticipated 56th GST Council Meeting took place on 3rd September 2025, marking a significant reform in India’s indirect tax structure. The Council approved a simplified GST rate system, reducing the earlier four slabs (5%, 12%, 18%, and 28%) to three key categories:

Standard Rate – 18%: Applicable to most goods and services.
Merit Rate – 5%: For essential commodities and priority sectors.
Demerit Rate – 40%: Applied selectively to sin goods and luxury items.

With effect from 22nd September 2025, the GST Compensation Cess will be discontinued for all goods, except for tobacco and related products such as cigarettes, pan masala, gutkha, chewing tobacco, zarda, unmanufactured tobacco, and bidi. The cess on these items will remain in place until the Central Government clears the pending loan and interest liabilities taken to compensate states for revenue losses during the COVID-19 period.

After the cess is fully withdrawn, tobacco and related products will be subject only to a 40% GST rate. The Finance Ministry will announce the cess withdrawal date once all financial obligations are settled.

What is Cess in GST?

In the context of GST, cess refers to the GST Compensation Cess, introduced under the Goods and Services Tax (Compensation to States) Act, 2017. It was implemented to compensate states for any loss of revenue following the rollout of GST in July 2017. The cess is levied on specific goods, mainly luxury items, sin goods, and tobacco products, ensuring that states continue to receive financial support despite shifts in tax collection under GST.

Post-September 2025 reforms, most goods no longer attract this cess, except tobacco and related products, which continue to be subject to the compensation cess until pending state compensation liabilities are cleared.

GST Rates 2025

Why is GST Cess Levied?

GST is a consumption-based tax, meaning the state where goods or services are consumed collects the indirect tax revenue. After the implementation of GST, certain states that were net exporters of goods or services faced potential revenue shortfalls.

To compensate these states for the loss of tax revenue, the GST Compensation Cess was introduced under the Goods and Services Tax (Compensation to States) Act, 2017. Originally levied for a period of five years from GST rollout, the cess has been largely phased out as of September 2025, except for tobacco and related products, which continue to attract the cess until pending compensation liabilities to states are fully cleared.

Usage of GST Compensation Cess

All proceeds collected from the GST Compensation Cess are credited to a non-lapsable fund, the Goods and Services Tax Compensation Fund. These funds are primarily used to compensate states for revenue shortfalls arising from the implementation of GST.

Following the GST reforms of September 2025, most cess collections for general goods have been discontinued, and only tobacco and related products continue to attract the cess until pending compensation loans to states are fully repaid. Any unutilized funds are managed by the Central Government to settle outstanding obligations, after which the balance will be distributed to states as per the revenue-sharing formula established under the GST Compensation Act.

Who is Required to Collect GST Compensation Cess?

All registered taxpayers involved in the supply of specified goods or services are required to collect and remit GST compensation cess, except for:

Exporters, and
Taxpayers registered under the Composition Scheme.

The cess also applies to imported goods, meaning that the compensation cess is levied on certain imports into India in addition to the basic customs duty and IGST.

If compensation cess is paid on goods or services that are subsequently exported, the exporter can claim a refund of the cess amount, ensuring that exports remain zero-rated under the GST framework.

GST Compensation Cess Applicability

As of September 2025 reforms, the GST Compensation Cess is now largely discontinued for most goods, except for specific categories such as tobacco and tobacco-related products.

The following product categories are now exempt from the GST Compensation Cess:

Aerated waters
Lemonade
Caffeinated beverages
Carbonated fruit drinks
Coal, briquettes, ovoids, and similar solid fuels manufactured from coal
Luxury cars and SUVs
Motorcycles with engine capacity over 350cc
Yachts and other vessels for pleasure or sports
Aircraft for personal use
Betting, online gaming, and casinos
Admission to sports events (e.g., IPL)

These changes were formalized under Notification No. 02/2025-Compensation Cess (Rate), dated September 17, 2025, issued by the Ministry of Finance.Compensation Cess Notification

Tobacco and Related Products – Compensation Cess Continues

Despite the broad exemptions, the GST Compensation Cess remains applicable to the following tobacco and related products:

Cigarettes
Pan masala
Gutkha
Chewing tobacco (including zarda)
Unmanufactured tobacco
Beedis

The continuation of the cess on these items is due to the pending settlement of compensation loans to states. Once these financial obligations are cleared, the government plans to replace the cess with a new levy on tobacco products. This transition is expected to occur during the upcoming winter session of Parliament.Higher Tobacco Tax

Also read: Tobacco GST RateGST Rate and Cess for Tobacco and Cigarettes

GST and Compensation Cess Rates – Tobacco Products

The GST Council has retained the following rates for tobacco and related products:

Product Description	GST Rate	Compensation Cess Rate
Cigarettes (non-filter, length ≤ 65mm)	28%	₹2,076 per thousand
Cigarettes (non-filter, length > 65mm but ≤ 75mm)	28%	₹3,668 per thousand
Filter cigarettes (length ≤ 65mm)	28%	₹2,076 per thousand
Filter cigarettes (length > 65mm but ≤ 70mm)	28%	₹2,747 per thousand
Filter cigarettes (length > 70mm but ≤ 75mm)	28%	₹3,668 per thousand
Cigarillos	28%	₹4,006 per thousand
Pan masala containing tobacco (gutkha)	28%	₹4,006 per thousand
Chewing tobacco (without lime tube)	28%	₹4,006 per thousand
Chewing tobacco (with lime tube)	28%	₹4,006 per thousand
Unmanufactured tobacco (with lime tube) – branded	28%	₹4,006 per thousand
Unmanufactured tobacco (without lime tube) – branded	28%	₹4,006 per thousand
Other smoking tobacco (bearing a brand name)	28%	₹4,006 per thousand
Other smoking tobacco (not bearing a brand name)	28%	₹4,006 per thousand

These rates are applicable until the central government repays the pending compensation loans to states.GST on Tobacco

Summary

Product Category	GST Rate	Compensation Cess Rate	Effective Date
Most goods (e.g., aerated waters, coal, luxury cars)	18% or 40%	Nil	September 22, 2025
Tobacco and related products	28%	As per existing rates	Ongoing until compensation loans are cleared

How to Calculate Cess on GST?

Calculating the GST Compensation Cess involves a simple formula based on the applicable GST rate for the product:

Step 1: Determine the Rate

Identify the consolidated GST rate applicable to the goods. For instance:

Luxury Cars: 40%
Aerated Drinks: 40%
Coal & Lignite: 18%

Tobacco products remain under 28% GST + Variable Cess.

Step 2: Calculate Taxable Value

Determine the supply value of the goods or services.

Step 3: Apply the Rate

Compute GST by applying the consolidated rate to the taxable value.

Example Calculation:

Luxury Car Price: ₹20,00,000
GST Rate: 40%
GST = 20,00,000 × 40% = ₹8,00,000

This approach simplifies compliance by integrating the compensation cess into the final GST rate for most products, reducing separate cess calculations.

Current Status and Distribution of GST Compensation Cess

Earlier, the GST Compensation Cess was directly transferred to states with a guaranteed 14% annual revenue growth, compensating them for any revenue loss post-GST implementation. However, this arrangement ended in June 2022.

Since then, the cess collections are no longer provided as direct compensation. Instead:

The collected cess is pooled into a dedicated fund.
It is used to service interest and repay the principal of loans taken by the Central Government.
These loans were used to cover state revenue shortfalls during the COVID-19 pandemic.

This ensures a structured repayment mechanism while keeping the fiscal stability of the states intact.

Input Tax Credit (ITC) and GST Compensation Cess

Input Tax Credit (ITC) under the Goods and Services Tax (GST) system allows businesses to claim credit for GST paid on purchases, capital goods, and services used in their operations. However, with respect to GST Compensation Cess, ITC usage is restricted. Businesses can only utilize ITC on Compensation Cess to offset their own Compensation Cess liability on output supplies. It cannot be applied against regular GST liabilities such as CGST, SGST, or IGST. This ensures that the benefit of ITC on Compensation Cess is strictly applied for its intended purpose, i.e., compensating states for revenue loss on specified goods and services.

Conclusion

The GST Compensation Cess has played a crucial role in safeguarding state revenues during the transition to a unified Goods and Services Tax system. With the September 2025 reforms, the cess has been largely phased out for most goods, simplifying compliance and reducing the tax burden on consumers. However, it continues to apply to tobacco and related products until pending compensation loans to states are fully repaid.