From levy to lapse: The mystery of compensation cess credit in GST 2.0 -Part II

In Part 1 of this article, we traced the evolution of Compensation Cess under the Goods and Services Tax (“GST”) regime – from its constitutional foundation and statutory framework to its levy on select sin and luxury goods, the mechanism for compensating States, and the circumstances that led to the extension of its life beyond the original five-year transition period. We also attempted to explain the paradigm shift brought about by the roll-out of GST 2.0, particularly the decision of the GST Council to effectively discontinue the levy of Compensation Cess (except on tobacco and related products) and merge the cess component into higher GST rates with effect from September 22, 2025.

The discussion in Part 1 culminated in identifying a critical and unresolved issue faced by industry: the blocking of accumulated Compensation Cess credit in the absence of any corresponding outward cess liability, coupled with the statutory bar on cross-utilisation of such credit.

In Part 2, we shall analyse the implications of Notification No. 2/2025–Compensation Cess (Rate) dated 17.09.2025 (“Notification dated 17.09.2025”) and explore possible statutory pathways for utilisation, transfer, or refund of the unutilised Compensation Cess credit.

Impact of the notification dated 17.09.2025

Notification dated 17.09.2025 was issued, amending the Notification No. 01/2017- Compensation Cess (Rate) dated 28.06.2017 (“notification dated 28.06.2017”) by which compensation cess was levied on various sin goods. By virtue of an amendment to the said Notification, the compensation cess on goods including motor vehicles, coal, motor cars etc., stands to be “NIL” with effect from September 22, 2025.  

As Section 11 of the Compensation Act states that provisions of the Central Goods and Services Tax Act, 2017 (“CGST Act”)/ Integrated Goods and Services Tax Act, 2017 (“IGST Act”), including those relating to input tax credit, non-levy, short-levy, interest, etc., shall, mutatis mutandis, apply, in relation to the levy and collection of the cess, it is pertinent to analyse the applicability of the relevant provisions for the purpose of interpreting the notification dated 17.09.2025.

Section 2(47) of the CGST Act defines "exempt supply". As per the said definition, exempt supply means supply of any goods or services or both attracting nil rate of tax or wholly exempt from tax in terms of  Section 11 of the CGST Act, or Section 6 of the IGST Act, and includes non-taxable supply.

The definition recognises a supply to be “exempt” in the following situations:

• When the rate of tax is nil;

• When it is wholly exempt from tax under Section 11.

If the notification dated 17.09.2025 is interpreted based on the definition of exempt supply, then there are two possible views. One, when the very same goods continue to be subjected to GST at applicable rates, mere non-levy of compensation cess cannot be the basis of deeming the supply to be “exempted”. The second view would be that the word ‘exempt’ must be read independently in each enactment, and for the purpose of compensation cess, the said supply being subjected to ‘Nil’ rate, is an exempt supply.

Purposive interpretation vis-à-vis literal interpretation

Hence, to understand as to which of the aforesaid views are correct, reference can be drawn to the FAQs published post 56th GST Council Meeting held on September 3, 2025, from which it can be inferred that the Council recommended to end the levy of Compensation Cess and merge the same with GST with effect from September 22, 2025 for all goods except tobacco and related products. Accordingly, the GST rates on station wagons, racing cars and other specified motor vehicles have been increased to 40%. Having regard to the intention underlying the issuance of the notification dated 17.09.2025, to interpret the term “nil” used in the notification based on the definition of exempt supply is contrary to the expressed intention, that is, to end the levy. This conclusion would be solely based on the ‘purposive interpretation’ ideology.

On the other hand, Section 11 of the CGST Act, 2017, empowers the government to exempt the levy of tax by way of a notification or special order. Notification dated 17.09.2025 has been issued under Section 8(2) of the Compensation Act, which provides for the levy and collection of compensation cess. There is no reference to Section 11 of the CGST Act, 2017, in the said notification. Hence, “nil” rate being a separate category of ‘exempt supply’, with the other being a wholly exempt by way of notification, will have to be considered as ‘exempt supply’, which is based on the rule of strict/ literal interpretation.

The aforesaid analysis unequivocally leads to the sole conclusion that by adopting either of the approaches, the assessees are not required to consider the ITC accumulated as lapsed in terms of Section 18(4) of the CGST Act, 2017, which is specifically attracted when the goods become wholly exempt.

With the ITC not lapsing and not being capable of utilisation as the proviso to Section 11 of the Compensation Act specifically restricts cross-utilization of cess credit towards CGST/ SGST/ IGST, the issue that demands an explanation is the status of such ITC.

Alternative 1 - Cross utilization of accumulated ITC

The government may allow the assessees to transfer the said credit to the IGST/ CGST credit ledger as requested earlier by the Federation of Automobile Dealers Association, which is clearly a legislative action requiring intervention from the government.

Alternative 2 -  Claim of refund of the accumulated ITC

Considering the provisions under Section 54(3) of the CGST Act and the decision of the Division Bench of Sikkim High Court in the case of Union of India vs. SICPA India Private Limited, which after interpretation of Section 49(6) has categorically held that even though the language in the said Section states that “may be refunded”, the words “in accordance with provisions of Section 54” makes it clear that refund of unutilised credit can be taken only under two circumstances, where:

(i)  zero-rated supplies are made without payment of tax;

(ii) where the credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies (other than nil-rated or fully exempt supplies).

Going by purposive interpretation, the accumulated credit is on account of the rate of tax on inputs being higher than the rate of tax on output supplies. When construed purposively, the caveat that the refund cannot be claimed if the rate of tax on output supplies is nil-rated or fully exempted will not affect the refund claim, as goods continue to be subject to GST at applicable rates. Hence, the same can be brought within the ambit of an inverted duty structure and a refund can be claimed under Section 54(3) of the CGST Act, 2017.

The entire chaos is on account of the usage of the term “nil”. If at all the intention of the Council was to end the levy, the entries could have been omitted vide the notification, which has not been done. Parallelly, the FADA has moved the Supreme Court seeking relief on the unutilized ITC pertaining to compensation cess post September 22, 2025. While a clarification on the interpretation of the term “nil” in the notification dated 17.09.2025 would be a welcome move, which will grant the much-required relief to the industry, a Supreme Court direction to the GST Council can help to trigger such a discussion, as seen earlier in the case of Union of India v. VKC Footsteps India Private Limited.

About the authors: Rishab J is an Associate Partner, Shri Gayathri and Princess Preet Kaur are Associates at Shivadass and Shivadass (Law Chambers).

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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