Centre proposes 5 and 18% rates under revamped GST regime: Sources

In his Independence Day address, Prime Minister Narendra Modi announced that the government will roll out next-generation reforms to the GST by Diwali, including a major reduction in tax rates. Addressing the nation from the Red Fort on the 79th Independence Day, the Prime Minister described the upcoming changes as a “Diwali gift” aimed at easing the tax burden on citizens.

Broadly the categories of items which will see a reduction in tax incidence are: agriculture, textiles, fertilizers, auto parts, handicrafts, medical devices and insurance, said officials. Petroleum products, however, are not part of the Centre’s proposals, and may remain outside the purview of GST as of now.

Moreover, another rate of 40% will exist – called the special rate – which will be imposed on 7-8 items, according to officials. "Tax incidence will be same on sin goods (tobacco, gutka, cigarettes) will be same as before … there will be no reduction," said the official.

As a result, there will be a short-term revenue impact for the Centre, but it might be compensated with a widening of the base, officials said. "I feel, by October-November, the changes will be accepted by the GST Council, and if that happens, we will have 5-6 months remaining in the fiscal year, which will help us compensate for short term impact," said another official.

The finance ministry doesn’t foresee any shortfall in its gross tax revenue collection target for FY26, due to the proposed changes in GST rates. The Centre’s gross tax revenue target for FY26 is Rs 42.7 lakh crore, up 11% on year.

On the compensation cess part, the Centre said that it will not continue once all the money borrowed earlier, for compensating to states, is repaid back. As per sources, the GST Council is expected to take a call on the future of the compensation cess by October, as the repayment of the GST compensation loan, raised to meet the shortfall in states’ revenues during the pandemic, is likely to be done ahead of schedule.

A compensation cess is levied on select luxury and sin goods —  such as cigarettes and high-end automobiles — in the 28 percent category. This cess, initially meant to shield states from revenue loss during the GST rollout for five years until June 2022, has been extended to March 31, 2026, to repay the Rs 2.69 lakh crore the Centre borrowed during the pandemic to fill the cess fund gap.

The Centre’s proposals also include correction of inverted duty structure for many essential items, such as textiles and fertilisers. "Once GST Council accepts, this issue will be resolved," said the first official. Inverted Duty Structure (IDS) refers to a situation where the tax rate on inputs (raw materials or services) is higher than the tax rate on the finished products.

Under GST, businesses can claim Input Tax Credit (ITC) for the taxes they pay on their inputs. This ITC is then used to offset the tax they are liable to pay on their final products (outputs). However, in an inverted duty structure, because the GST rate on inputs is higher than the rate on outputs, a business ends up with an accumulation of unutilized ITC. They pay more tax on their purchases than they collect on their sales, leading to a financial imbalance and a blockage of working capital, as per experts.

The Centre also wants the proposed changes, once through, to provide stability to businesses and consumers. "We don’t aim to change them frequently," said the first official. A simpler tax structure shall additionally lead to lower disputes, the person added.

There is a proposal on easing registration process for small businesses as well. The Centre wants the entire registration process of MSMEs to GST to be automated, and complete the entire process in mere 3 days - -which takes weeks as of now. And on refunds, the Centre is executing a plan, proposed to the GoM, which will help in substantial refunds completion as soon as an application is filed by a business. Refunds will also be provided on inverted duty structure going forward, which is not the case presently.

Earlier today, the finance ministry said on X that the Centre has taken this initiative with the aim of building a constructive, inclusive, and consensus-based dialogue among all stakeholders. “In the true spirit of cooperative federalism, the Centre remains committed to working closely with the States. It will be building a broad-based consensus with the States in the coming weeks, to implement the next generation of reforms as envisioned by PM Modi,” said the finance ministry.

"The GST Council, when it meets next, will deliberate on the recommendations of GoM, and every effort will be made to facilitate early implementation so that the intended benefits are substantially realised within the current financial year," the ministry said.

The planned restructuring is being timed with the stabilisation of GST collections and strong macroeconomic indicators. The move also aligns with India’s upcoming free trade agreements with several developed economies, where the government is seeking to remove tariff barriers that could hold back domestic industry growth.

In July, reports indicated that the Prime Minister’s Office had given an in-principle nod to the overhaul. For consumers, the most visible change could be the migration of several goods from the 12 percent slab to the 5 percent category, directly reducing retail prices.