(MENAFN- Live Mint) NEW DELHI: The Centre on Monday moved to overhaul the taxation of tobacco and related products, including cigarettes, snuff, smoking mixtures, and pan masala, by phasing out the goods and services tax (GST) compensation cess and raising excise duties. Finance Minister Nirmala Sitharaman tabled two Bills in the Lok Sabha aimed at keeping overall tax incidence steady while ensuring states benefit from excise revenues.

Tobacco products are subject to both GST and central excise duty. To preserve the overall tax burden after discontinuing the compensation cess, the government has proposed amending the Central Excise Act and introducing a new cess in its place.

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The Central Excise (Amendment) Bill, 2025, proposes raising excise duty on tobacco products. For example, the duty on tobacco would increase from 64% to 70% once implemented. Unlike cess proceeds, Centre's tax revenue receipts such as GST, income tax, and excise duty are shared with states.

The Bill noted that with the introduction of GST in 2017, the excise duty on tobacco and products, some of the few products on which the levy was retained, was“reduced significantly to allow for the levy of compensation cess without large impact on their tax incidence.”

“Compensation cess levied on tobacco and tobacco products, wherever applicable, will be discontinued once interest payment obligations and loan liabilities under the compensation cess account are completely discharged,” it added.

Tobacco and its products such as cigarettes, pan masala, gutkha currently attract 28% GST and a compensation cess that goes up to 290% in some cases such as smoking mixtures for pipes. After their transition to the new rate structure at a time to be decided by the finance minister, these will move to the 40% GST slab and the remaining gap is likely to be met by the proposed new cess and any additional excise duty.

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The Health Security and National Security Cess Bill, 2025, proposes a new cess aimed at public health and national security. It will be levied, in part, on the production capacity of pan masala producers, a sector considered prone to tax evasion. The Bill allows for other tobacco products to be included under capacity-based taxation through notification, but pan masala is specifically listed.

Under capacity-based taxation, the cess payable is calculated based on the production capacity of installed machines, rather than the actual quantity of products leaving the factory.

The Bills come as the Centre is expected to fully repay before March the ₹2.69 trillion debt it raised to support the states during the pandemic from the proceeds of the compensation cess.

Tax reforms

Mahesh Jaising, partner and Indirect Tax Leader at Deloitte India, said that with the sunset of the GST Compensation cess, GST 2.0 brings a more streamlined and transparent framework, reducing complexity for businesses while strengthening compliance.

“At the same time, the new Bill on health security and national security cess and the excise duty amendment ensure that critical national priorities-public health and security-are supported through a dedicated revenue stream from select goods,” said Jaising.

It is expected that the total tax incidence would largely remain the same for tobacco and pan masala, he added.

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“Importantly, the cess will be operationalized through a capacity-based tax model, where manufacturers self-declare machinery and production capabilities, ensuring predictability and reducing evasion. Together, these measures are expected to balance fiscal sustainability with economic growth, creating a predictable and progressive tax environment for industry and government alike,” Jaising noted.

Earlier, the GST Council had examined capacity-based taxation for the sector but chose not to implement it, since GST is a tax on consumption rather than production. The new effort attempts this model, at least for pan masala under the proposed cess.

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