Exclusive: Govt evaluating multiple options to keep tobacco cess alive in post-compensation regime

The Centre is examining a series of fiscal and legislative options to ensure that the tax burden on tobacco products remains intact once the GST Compensation Cess framework comes to an end, highly placed government sources told CNBC-TV18.

The discussions, currently underway between the Finance Ministry and the Prime Minister’s Office, aim to ensure that the revenue from tobacco continues to remain outside the divisible pool, preserving the Centre’s fiscal space, sources added.

However, no final decision has been taken yet, multiple officials familiar with the matter emphasised.

According to sources, the government is likely to announce a mechanism to replace the existing compensation cess on tobacco products in Budget 2026, as the current levy will continue only until the back-to-back loans issued to states during the pandemic are fully repaid.

Tobacco products, along with aerated drinks, automobiles and coal, attracted a hefty compensation cess over and above the 28% peak GST rate, under the earstwhile GST regime. But, post the GST rate rationalisation which was announced in the 56th GST Council in September, the levies have not changed only for tobacco products, and they continue to attract 28% GST plus the compensation cess, which ranges from 5% to 290%, depending on the type and form of the product.

With the Compensation Cess regime approaching its sunset – March 2026, the Centre faces the challenge of preventing any significant erosion of tax revenue from tobacco — a sector heavily taxed both for public health considerations and revenue mobilisation, sources added.

Multiple replacement options on the table

Sources said that the three broad alternatives which are being actively considered are:

1. Subsuming the levy under existing National Calamity Contingent Duty (NCCD): Sources shared that the view here is that his move would allow the Centre to continue collecting a cess-like charge exclusively for its own use. NCCD is currently imposed on select goods, including crude oil and tobacco products, with proceeds funneled into the National Disaster Response Fund (NDRF). Reclassifying the tobacco cess under this mechanism would preserve the Centre’s ability to ring-fence the revenue.

2. Introducing an entirely new cess: Sources shared that the government may create a standalone levy specifically designed to replace the compensation cess. The broad objective would be to keep the proceeds outside the divisible pool and retain fiscal autonomy on this revenue stream. The name and structure of the levy could be as any other “cess”.

3. Continuing the levy under a different name: Sources say that another option is a cosmetic but operationally similar substitute — renaming or restructuring the existing cess without fundamentally altering the taxable base or rate. This would ensure continuity and administrative ease, especially for tax authorities and the industry. So a new nomenclature, which is not a cess, as all cesses were to be subsumed under GST, at the time of introduction of GST and sources say that this is one of the most possible and plausible option as it will give greater autonomy to the Centre.

However, a senior official said, “All options are currently being studied closely. The key is to ensure that the quantum of cess on tobacco products does not lapse, as it remains a critical revenue source.”

Why the Centre wants the levy outside GST

Officials said the government is unequivocally in favour of keeping tobacco taxation outside the GST divisible pool, which determines how tax proceeds are shared between the Centre and states. The Compensation Cess, by design, has always been excluded from this pool, allowing the Central government not to use the revenue as it was exclusively for compensating states for GST revenue shortfalls.

With that obligation tapering off, the Centre is keen to preserve the same exclusivity for fiscal flexibility, now with Centre no longer with the states, sources added.

Tobacco, with its high revenue yield compared to other goods, remains a strategic component of this approach.

Budget 2026 likely to be the announcement platform

While discussions are still ongoing, sources indicated that an announcement in Budget 2026 is likely — aligning with the Centre’s broader tax restructuring agenda.

For now, officials stress that the industry should expect continuity in taxation levels rather than any reduction. “The intention is not to dilute the tax incidence on tobacco but to preserve the existing structure in a post-cess regime,” a source noted.

As the countdown to Budget 2026 begins, the government appears determined to ensure that the high tax burden on tobacco—a critical health and revenue instrument—remains firmly in place, even as the GST compensation era draws to a close.Read about our editorial guidelines and ethics policy