States will not have to pay either the principal or interest if they opt to borrow only Rs 97,000 crore to meet the shortfall in Goods and Services Tax (GST) compensation arising from GST implementation issues, but they will have to bear significant interest costs if they choose to borrow the entire shortfall of Rs 2.35 lakh crore, which includes revenue losses arising from the Covid-19 pandemic, the Union finance ministry said in a statement released Saturday.

In the case of option 1, the interest and the principal will both come from the compensation cess levied on luxury products and sin goods, and in option 2, only the principal will come from this, finance ministry officials said on condition of anonymity.

They added that the cess on such products will continue beyond the current deadline of June 30, 2022. The compensation cess was originally levied only for a five-year period to bridge shortfalls in the guaranteed payments to states with 14% growth in revenue. As the proposed debt options will be serviced from the compensation cess fund, the levy will continue for longer, the officials said.

The government has sought to distinguish between the shortfall arising from GST implementation — by the letter of the law, it is liable to pay only this to the states — and that from an “Act of God”, in this case, Covid-19. It is a nuance that isn’t lost on the states, with those ruled by non-BJP parties outraged by the idea.

At the 41st GST Council meet held on Thursday, the Centre offered the two options to the states and promised to share details by Saturday.

The Union finance ministry said in its Saturday statement: “The two borrowing options to meet the GST Compensation requirement for 2020-21 consequent to the discussions in the 41st meeting of the GST Council held on 27th August, 2020 has been communicated to States.” States have been given seven working days to communicate their preference, it added.

“A meeting of State Finance Secretaries with the Union Finance Secretary and Secretary (Expenditure) is scheduled to be held on 1st September, 2020 for clarifying issues, if any,” it said.

Explaining details of the two options proposed to the states, the Centre’s communiqué to the states said, in case they opt for the second option to borrow Rs 2.35 lakh crore, they will have to pay interest from their own resources.

One of the officials mentioned above said the GST Act provides for compensation to the states for the loss of revenue arising “on account of implementation” of GST. “In essence, the compensation payable is the projected revenue (at a compound growth rate of 14% from the base figure of 2015-16) minus the actual revenue in each period,” he said, citing from the Act.

“Therefore, the Rs 97,000 crore is fully covered by GST compensation cess as per the law, and interest on borrowings over and above that amount will be borne by the states. In any case, the principal will be eventually paid from the cess fund,” he added.

The GST law assures states a 14% increase in their annual revenue for five years from July 1, 2017 and also guarantees that their revenue shortfall, if any, would be made good through the compensation cess levied on luxury and sin products such as liquor, cigarettes, aerated water, automobiles, coal and tobacco products.

An indirect tax expert said on condition of anonymity that the Centre’s letter issued on Saturday could split the council. “This could polarise the GST Council. It appears that the Bharatiya Janata Party (BJP)-ruled states will go for the first option and the Opposition-ruled states may go for the second option as they would like to borrow more to tide over the current crisis,” he said.

West Bengal finance minister Amit Mitra will hold a press conference at 2pm on Sunday to explain why the centre’s proposal on GST is totally unacceptable, said a Trinamool Congress leader who didn’t wish to be named.

MS Mani, partner at consultancy firm Deloitte India, said: “It will not be an easy choice for the cash-strapped states. The communiqué, however, makes it clear that neither Centre nor states are willing to include more items under the ambit of cess or raise its rates at least for a year because of the prevailing economic condition. But, it fails to address the larger issue of raising GST collection at a time when overall tax revenue, for both Centre and the states, is falling.”