Context:

Recently, the Union Government notified 1 February 2026 as the effective date for a major restructuring of India’s tobacco taxation framework. This notification marks the formal end of the GST compensation cess and the beginning of a new tobacco tax regime that combines higher GST rates, additional central excise duties, and a Health and National Security Cess.

Background:

• • • When the Goods and Services Tax (GST) was rolled out in July 2017, the Centre assured states compensation for any revenue losses arising from the transition to a unified indirect tax system. To finance this commitment, a GST compensation cess was imposed on select goods such as tobacco, pan masala, and luxury items.
    • During the COVID-19 pandemic, the Centre resorted to borrowing to continue compensation payments to states, creating temporary liabilities. These liabilities have since been fully repaid. With the compensation period concluded and outstanding obligations extinguished, the cess has outlived its original purpose. Consequently, the government has decided to phase it out, paving the way for a new taxation structure effective from February 1, 2026.

New Tobacco Tax Regime:

• • • Under the revised framework, tobacco products will continue to be taxed under GST, albeit with higher rates and additional levies. Cigarettes, pan masala, and similar products will attract 40% GST, while bidis will fall under the 18% GST slab.
    • A significant reform is the introduction of an MRP-based valuation system, under which taxes will be levied on declared retail prices rather than transaction values, thereby addressing the problem of under-invoicing.
    • In addition, central excise duties will be imposed on tobacco products, varying by product category and specifications. Pan masala will attract a Health and National Security Cess, while products such as gutkha and chewing tobacco will be subject to capacity-based excise duties linked to packing machine capacity.
    • Regulatory oversight is further strengthened through the Packing Machines Rules, 2026, which mandate disclosure of machine details and monthly duty payments.

Rationale Behind the Shift:

• • • The new regime is guided by three core objectives.
      • First, fiscal sustainability is enhanced by replacing a temporary and purpose-specific cess with more predictable excise-based revenues.
      • Second, public health objectives are reinforced by maintaining a high tax burden on harmful products, thereby discouraging consumption.
      • Third, administrative efficiency is improved through MRP-based valuation and capacity-linked duties, which reduce opportunities for tax evasion and revenue leakage.

Economic and Social Implications:

• • • Higher taxation is expected to increase retail prices and potentially dampen consumption, although demand for tobacco products tends to be relatively inelastic due to addiction.
    • The industry has responded negatively, with tobacco stocks declining amid concerns over profitability and margins. For states, revenues will now accrue through the divisible pool rather than a dedicated cess, while a portion of the proceeds may be earmarked for health-related programmes. This transition will require careful Centre–State coordination to ensure revenue stability.

Conclusion:

The notification ending the GST compensation cess and introducing a new tobacco tax regime represents a significant shift in India’s indirect tax policy. By aligning revenue mobilisation with public health priorities and compliance objectives, the government seeks to establish a more efficient, health-oriented, and fiscally stable taxation framework. The success of this reform will ultimately depend on effective enforcement, complementary public health measures, and sustained vigilance against illicit trade.