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India Ends GST Compensation Cess, Ushers in New Tobacco Tax Regime from February 1
New Delhi | January 1, 2026
India’s indirect tax architecture entered a decisive new phase on New Year’s Day as the Union government formally notified February 1, 2026 as the end of the GST compensation cess and the beginning of a new, tougher tobacco tax regime. The move closes a nearly nine-year chapter in India’s post-GST fiscal history and signals a sharper alignment of taxation policy with public health and national security objectives.
In a series of notifications issued by the Ministry of Finance, the Centre confirmed three major changes:
the sunset of the GST compensation cess, a significant restructuring of excise duties on tobacco products, and revised GST rates that fundamentally alter how cigarettes, bidis, and smokeless tobacco are taxed.
A Cess Born with GST, Ending with It
The GST compensation cess was introduced in July 2017, alongside the launch of the Goods and Services Tax, as a constitutional assurance to States. Its sole purpose was to compensate States for revenue losses arising from the shift to a unified tax system, guaranteeing them a fixed annual growth in tax receipts.
Originally designed for five years, the cess was meant to expire in 2022. However, the COVID-19 pandemic severely disrupted tax collections. To honour its commitment to States, the Centre borrowed funds and extended the cess until 2026, earmarking collections primarily to repay those loans.
With the bulk of the borrowing now close to being settled, the government has formally brought the cess to an end. From February 1, it will no longer apply even to tobacco products, the final category on which it continued after September 2025.
Why Tobacco Is Being Taxed Differently Now
The end of the compensation cess does not mean lower taxes on tobaccofar from it. Instead, the government has replaced a temporary GST-linked levy with permanent excise and cess-based instruments under new laws passed by Parliament.
Two statutes are central to this shift:
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Central Excise (Amendment) Act, 2025
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Health Security and National Security Act, 2025
Together, they restore the Centre’s ability to impose meaningful excise duties on tobacco, a power that had become largely symbolic under GST.
In an official FAQ accompanying the notifications, the Finance Ministry noted that excise duty on cigarettes had effectively been reduced to a “fraction of a paisa per stick” under GST, while compensation cess rates had remained unchanged since 2017. As a result, cigarette affordability had either stagnated or increased over the past decadecontrary to global public-health recommendations.
New Excise Duties and a Dedicated Cess
From February 1, excise duty rates on tobacco products will rise sharply under the amended law. In addition, the Health Security and national security cess—already applicable to pan masalawill come into force across a wider range of products.
The government’s justification is twofold:
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Public Health:
International health bodies consistently recommend regular increases in specific excise duties to ensure tobacco prices rise faster than incomes. The new regime is designed to reverse years of relative price stability. -
National Security Financing:
The Centre has argued that conventional tax revenues are subject to competing priorities and cannot always guarantee sustained funding for defence preparedness. A dedicated, non-lapsable cess creates a predictable revenue stream without raising broad-based taxes such as GST.
GST Rates: A Clear Reshuffle
Alongside excise changes, the Finance Ministry has also notified new GST slabs for tobacco products, effective February 1:
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Bidis: moved to the 18% GST slab, down from the earlier 28% category....
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All other tobacco products: placed in a 40% GST slab, reinforcing their classification as demerit goods...
This restructuring simplifies rate classifications while ensuring that overall tax incidence on most tobacco products remains high when combined with excise and cess levies....
New Valuation Rules for Smokeless Tobacco
One of the most consequential changes lies in valuation. Products such as chewing tobacco, filter khaini, jarda, scented tobacco, and gutkha will now be taxed based on the retail sale price declared on the package.
By linking GST valuation directly to printed prices, the government aims to curb under-reporting and leakage, a long-standing concern in the smokeless tobacco segment.
Political and Institutional Backdrop
The new tax regime was enabled by legislation passed during the Winter Session of Parliament, reflecting a broad political consensus that the compensation cess had outlived its purpose. While States had once fiercely guarded the cess as a revenue lifeline, its relevance diminished as GST collections stabilised and pandemic-era loans were repaid.
Policy insiders note that the shift also restores clearer fiscal lines: GST remains a shared tax, while excise and cesses once again give the Union government direct control over “sin goods” taxation.
What It Means for Consumers and Industry
For consumers, particularly smokers and users of smokeless tobacco, the changes are likely to translate into higher prices over time, even where GST rates appear lower. The combined effect of excise, cess, and GST ensures that tobacco remains among the most heavily taxed commodities in the country.
For manufacturers, the transition brings tighter compliance requirements, new valuation norms, and a more complex duty structure. Analysts expect companies to reassess pricing strategies and product mixes in response.
The End of an Era, the Start of Another
The formal end of the GST compensation cess marks more than a technical tax change. It symbolises the conclusion of India’s most delicate GST compromisethe promise to shield States during the transition—and the start of a more assertive phase of fiscal policy.
By restructuring tobacco taxation, the government has signalled that revenue protection, public health, and national security can be pursued simultaneously, even if it means hardening the tax stance on politically sensitive products.
- As February 1 approaches, all eyes will be on how effectively the new regime is implemented
and whether it finally succeeds in making tobacco progressively less affordable in India
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