Govt. notifies February 1 as the end of GST compensation cess, start of new tobacco tax regime

The Ministry of Finance on Thursday (January 1, 2026) issued a series of notifications that would bring into effect the new taxation regime for tobacco products from February 1, 2026.

First of all, it notified that the Central Excise (Amendment) Act, 2025, passed in the recently-concluded Winter session of Parliament, would come into force from February 1, 2026. This Act specifies new rates of excise duty on tobacco products. It also notified that the provisions of the Health Security se National Security Act, 2025, which currently levies a cess on the manufacture of pan masala, will come into force from February 1, 2026.

In an accompanying FAQ note, the Ministry explained that, under the Goods and Services Tax regime, the excise duty on cigarettes had so far been rendered a nominal amount of a “fraction of a paisa” per cigarette stick, and that the GST compensation cess rate on tobacco products had not been increased since it was implemented in July 2017.

“For India, affordability has either stagnated or increased in the past decade, meaning cigarettes have not become more expensive relative to consumers’ purchasing power,” the note said. “This is contrary to global public-health guidance, which emphasises annual increases in specific excise duties to ensure that real cigarette prices rise faster than incomes.”

At the same time, the Ministry of Finance also notified February 1, 2026 as the date from which the GST compensation cess would cease to exist. The cess was originally introduced for a period of five years to compensate States for any loss arising out of the implementation of GST.

However, due to the COVID-19 pandemic, the cess collections were not enough to compensate the States and so the Centre borrowed money to compensate them. The cess, which was to end in 2022, was extended until 2026, with the proceeds being used to repay the loan.

Restoring fiscal space for the States

With the impending end of the loan, the government on September 22, 2025, removed the incidence of the cess on most items except tobacco items. From February 1, 2026, the cess will no longer apply on these items either, effectively ending it.

At the same time, the Finance Ministry also notified the new GST rates for tobacco products. Bidis have been moved to the 18% category from the now-defunct 28% slab. All other tobacco products have been moved to the 40% slab. These new rates will be effective from February 1, 2026.

Finally, the Ministry also introduced a new valuation mechanism for tobacco products such as chewing tobacco, filter khaini, jarda, scented tobacco, gutkha, etc, whereby the GST value would be determined based on the retail sale price declared on the package.

Regarding the Health Security se National Security Act, 2025, the Ministry justified the inclusion of the national security aspect by saying that conventional tax revenues cannot always guarantee funding for national security functions, and so a dedicated cess is needed for the purpose.

“General tax revenues are subject to competing developmental priorities and cannot always guarantee sustained long-term funding for core national-security functions,” the FAQ note said. “A dedicated purpose-specific cess enables the Union to create a non-lapsable, predictable financial stream that supports multi-year security preparedness, technological upgradation, capacity creation, and advanced equipment procurement — without increasing the tax burden on the general population or raising broad-based rates such as GST.”