GST 2.0: Decoding the New Tax Architecture

The GST Council recently unveiled the long-awaited GST 2.0 reforms, a pivotal step in India’s tax evolution. By scrapping the 12% and 28% slabs and rationalising rates, this will simplify the framework around indirect tax and inject fresh momentum into the economy. Since its inception, GST has drawn scrutiny for its complexity and unintended distortions. These reforms mark a recalibration intended to restore confidence and improve the ease of doing business against the backdrop of global trade pressures and domestic growth challenges. At a recent IMA India CFO Forum session, Mukesh Butani, Managing Partner at BMG Legal Advocates examined the implications of the reforms, their reception among businesses and policymakers and the road ahead for India’s tax architecture.

Drivers of GST 2.0

GST 2.0 was rolled out against the backdrop of a mixed economic outlook. While Q1FY26 delivered stronger-than-expected growth, this was largely fuelled by rural consumption and utility demand, with urban consumption remaining weak. At the same time, the imposition of a 50% US tariff threatened to shave 0.5-0.6% off growth, prompting policymakers to introduce countervailing measures. These changes also intend to address structural inefficiencies, with the potential to add ~60 basis points (bps) to GDP over the next year. Industry-level pressures underline the urgency: automobiles face slowing demand, FMCG growth has flattened for 7 consecutive quarters and textiles continue to struggle with slim margins and competitiveness issues.

Challenges Addressed, Opportunities Unlocked

The GST regime has long suffered from structural flaws that create complexities for businesses. Multiple slabs lead to classification disputes, compliance burdens and avenues for evasion, while inverted duty structures in sectors such as textiles and fertilisers erode revenue neutrality. For textile businesses, higher input taxes have left firms carrying unutilised credits, while for fertiliser companies, despite inputs being moved to the 5% slab, packaging materials were being taxed at 18%, leaving a residual anomaly. The absence of a functional GST Tribunal compounded these pressures, forcing disputes into the High Courts, while MSMEs in particular faced delayed refunds, intrusive scrutiny and frequent registration rejections.

GST 2.0 seeks to address these pain points while stimulating demand. Rates on over 295 essential goods and services have been reduced from 12% to 5%, a shift that could trim inflation by 65-75 basis points and raise disposable incomes when combined with revised income-tax slabs. At the same time, goods classified as luxury or ‘sin’ items are proposed to be taxed at 40%, reflecting a deliberate balancing act between boosting mass consumption and safeguarding revenues. The reforms are also likely to revive demand for FMCG, cement, textiles and pharmaceuticals while easing structural bottlenecks and bolstering consumer confidence. By cushioning the impact of external tariffs and driving discretionary spending, GST 2.0 positions itself not only as a short-term consumption boost but also as a long-term structural correction for the economy.

These benefits, however, come at a fiscal cost. Treasury revenues are projected to fall by Rs 500-900 bn, though this is far less than the Rs 2 tn loss predicted by some commentators. However, the government is betting on buoyant demand to offset much of this shortfall. With the fiscal deficit impact already accounted for in budgetary projections, investor sentiment is unlikely to suffer. If demand momentum extends beyond the immediate 3-quarter horizon, these reforms are likely to embed themselves as a permanent feature of India’s tax architecture.

Business and Compliance Implications

Supply Chains

The reforms will necessitate a recalibration of supply chains. Businesses will have to renegotiate terms with suppliers to ensure that the benefits of rate cuts are passed through, while managing the disposal of older stock and raw materials procured at higher tax rates. These transitional frictions, coupled with the operational complexity of implementing changes across procurement and distribution networks, will create short-term hurdles before stabilisation sets in.

Anti-Profiteering

A central concern is a renewed focus on anti-profiteering. While the original provisions were withdrawn, recent statements from policymakers indicate that mechanisms to monitor benefit passthrough may be revived. FMCG companies are especially vulnerable, given the sector’s visibility and history of disputes. The Delhi High Court’s 2024 judgment upholding the validity of the authority reinforces the likelihood of closer scrutiny and possible penalties. Businesses will be expected not only to manage supply-side adjustments but also to demonstrate transparency in how tax savings are shared with consumers.

Pricing Challenges

Translating the rate cuts into lower consumer prices poses complex dilemmas, especially for consumer-facing sectors such as FMCG and automobiles. Businesses are expected to pass on the benefits of lower rates, but many had also deferred planned price hikes for strategic reasons. The question is whether reductions can be offset against delayed increases, and how to demonstrate compliance if challenged under anti-profiteering provisions. With enforcement now routed through the Competition Commission of India, judicial precedents suggest that companies must be prepared to justify their pricing strategies with clarity and evidence.

The need to comply with the Legal Metrology Act compounds these pressures. From September 22nd , all products must carry revised MRPs, through re-labelling, stamping or online printing, while retaining the original price, with the difference between old and new not exceeding the change in tax rate. This creates significant logistical hurdles, particularly for firms holding large inventories. Pricepoint packs in FMCG add further difficulty, as fractional adjustments are impractical. Though some firms may resort to increasing quantities, courts have previously rejected this as a valid substitute for price reductions, leaving businesses vulnerable to scrutiny.

Compensation Cess

The fate of unutilised compensation cess remains unresolved and is perhaps the most pressing issue for certain industries. Current indications are that unused balances may lapse, which could result in significant losses. The automobile sector alone is estimated to face an exposure of Rs 14 bn. Dealers have responded by offering discounts in an attempt to liquidate credits, but the tight deadlines make full utilisation unlikely. While equity considerations argue for an extension, particularly given that the cess was previously prolonged until 2026, there is no official clarification yet. The risk of stranded credits compels businesses to engage with policymakers and prepare for multiple scenarios.

Changes in ERP Systems

Finally, the reforms demand technical adjustments within ERP systems, whose tax engines must be reconfigured to accommodate new rate structures, while compliance protocols for return filings require careful recalibration. These changes, though often overlooked in public discourse, involve significant time and resource commitments. For large organisations, seamless adaptation of systems will be critical to ensuring compliance and avoiding operational bottlenecks.

Impact on Investment Incentives

A less visible consequence of GST reform is the erosion of state-level GST incentives, which were central to investment decisions in sectors such as cement and automobiles. Many states had offered undertakings net GST refunds or credits against fixed capital investments over multi-year horizons; with output tax rates now reduced, the quantum of incentives automatically shrinks, undermining the original economic viability of projects. Extending the tenure of such schemes could partially soften the blow, but the net present value of benefits would remain diminished. Past experience suggests that compensation is unlikely, with large auto players who invested under pre-GST VAT deferral or loan-conversion schemes seeing their benefits lapse once GST came into force.

Operationalisation of GSTAT

The GST Appellate Tribunal (GSTAT), envisaged in 2017 as the principal forum for GST dispute resolution, has been stalled for years due to disagreements over its composition, litigation around member qualifications, inadequate infrastructure and delays in legislative amendments. The political focus at the time was concentrated on establishing the GST Council, leaving the tribunal underdeveloped. In its absence, taxpayers turned to High Courts for relief, leading to a build-up of appeals, stay orders without resolution on merit and fragmented interpretations across states. Under GST 2.0, the tribunal is set to become functional by end-2025, with appeals expected to be admitted from September and hearings beginning in December. Its operationalisation is expected to ease judicial backlogs, create consistency in tax interpretation and deliver the speedier dispute resolution that businesses have long sought, thereby restoring confidence in the GST framework.

Who Will Benefit?

• Automobiles and Auto Components: The sharp reduction in GST on auto components from 28% to 18% is expected to provide immediate relief to domestic manufacturers such as Tata, Maruti and M&M, as well as the broader auto-ancillary ecosystem. By easing cost pressures, this could revive demand in a sector that has been facing slowing sales, while also improving competitiveness across the supply chain.

• Healthcare: This is likely to be one of the biggest beneficiaries of the reforms, with GST rates cut to 5% across the board and life-saving drugs and equipment brought to a nil rate. This aligns with earlier customs concessions on medical imports, reinforcing affordability and accessibility. The reforms will boost investment, expand coverage and advance public policy objectives around universal healthcare.

• Textiles: The reduction of GST on man-made fibres from 18% to 5% addresses a long-standing inverted duty structure that disproportionately hurt SMEs. By easing refund pressures and lowering costs across the value chain, the changes are expected to support domestic production and competitiveness, though it may not fully offset the current export headwinds.

• Electronics and Appliances: High-incidence goods such as air-conditioners and televisions will now fall under the 18% slab, correcting the anomaly of treating widely-used appliances as luxury products. The move is expected to stimulate demand, support domestic manufacturing under the PLI regime and improve affordability of such goods for middle-income households.

• Insurance: Life and health insurance have been virtually exempt from GST, removing the 18% levy that long deterred middle-class buyers and lowering a key barrier to penetration. While this is expected to improve affordability and expand coverage, the exemption also withdraws input tax credits, raising operating costs for insurers. The sector thus faces a pricing dilemma: premiums must reflect higher costs but regulators will expect that the benefit of exemption is transparently passed on to consumers. With heightened scrutiny likely, insurers will need to justify pricing strategies carefully to balance affordability with compliance.

The Future Roadmap for GST

The breadth of these reforms notwithstanding, several structural issues remain. Key state-level levies such as road tax, entertainment tax and electricity duty remain outside the GST framework, raising costs and fragmenting the tax base. The absence of consensus on bringing petroleum products into the GST, despite provisions in the 2017 law that allow for simple notification, remains a major distortion, while alcohol will require a constitutional amendment to be included. Input tax credit on construction activities continue to be disallowed, inflating costs for housing and infrastructure projects and creating a cascading burden ultimately borne by consumers. Real estate in general remains a critical area for future reform. The sector continues to grapple with dual burdens of stamp duty, which is controlled by the states, and GST on inputs, both of which inflate costs for buyers. Given its role in economic formalisation, foreign investment and capital mobilisation, the sector is the ideal candidate for future reforms once broader stakeholder consensus is achieved.

Ambiguities persist in the treatment of long-term leases, which are categorised as services but remain contested between state and Central jurisdictions. Frequent and significant legislative changes further add to compliance complexity, forcing businesses to repeatedly adjust ERP systems and pricing structures, often at short notice. While certain pain points such as intermediary services have been addressed and a gradual withdrawal of the compensation cess has been indicated, the larger roadmap underscores that GST’s design is still only partially aligned with global best practice. Further reforms will be necessary to deliver a more stable, comprehensive and predictable tax regime