New GST Mechanism to Boost States’ Revenue from Feb 1

New GST mechanism for tobacco and pan masala to raise States’ revenue from February 1

New Delhi: A new GST mechanism for cigarettes, tobacco products and pan masala will come into effect from February 1, a move that government sources say will increase the share of revenue flowing to States without altering the overall tax burden on these products.

The Finance Ministry has notified the implementation date following the enactment of the Health Security and National Security Cess Act and amendments to the Central Excise framework. From February 1, the existing compensation cess on these products will be discontinued.

Higher State share without raising tax incidence

Under the revised structure, pan masala will attract a combined levy of 40 per cent GST along with a purpose-specific cess. Cigarettes and other tobacco products will be subject to 40 per cent GST, in addition to excise duty under the Excise Act and the National Calamity Contingent Duty.

Currently, these products attract 28 per cent GST along with a compensation cess. Sources clarified that while the structure of taxation is changing, the effective tax incidence remains unchanged. For pan masala, the overall tax burden will continue at around 88 per cent, while tobacco products will maintain their existing incidence.

Why States gain more under the new framework

Officials explained that the shift benefits States because excise duty forms part of the divisible tax pool and is shared with States according to the Finance Commission formula. Any increase in excise collections therefore directly raises the quantum of funds devolved to States.

In addition, part of the tax burden earlier collected as compensation cess has now been moved into GST by increasing the GST rate to 40 per cent from 28 per cent. Since States receive a significant share of GST through SGST and IGST settlements, this change ensures a higher and more predictable revenue stream for them.

Compensation cess ends as loans are repaid

The compensation cess was introduced as a temporary measure to offset revenue losses faced by States after the rollout of GST. Though originally meant to last five years, it was extended to service back-to-back loans taken during the pandemic.

With those loans now repaid, the cess is set to end. Officials pointed out that under Article 270 of the Constitution, purpose-specific cesses imposed by Parliament are not shareable with States, which is why the earlier compensation cess collections were not devolved.

Public health, security and compliance impact

According to sources, the new mechanism strengthens funding for public health and national security initiatives while keeping the GST framework intact. The revised structure is also expected to curb chronic tax evasion in high-risk sectors such as tobacco and pan masala by simplifying enforcement and improving traceability.

From a compliance perspective, changes in tax structure place renewed emphasis on accurate reporting, classification and duty reconciliation. This is where robust internal checks and professional review - commonly supported by auditing services in india
- become critical for businesses operating in regulated, high-tax segments.

The government maintains that the revised mechanism balances fiscal federalism with policy objectives, ensuring States receive a higher share of revenues without increasing the burden on consumers.