New Delhi: The Centre on Wednesday issued an order giving effect to a new law levying a health and national security cess on tobacco and its products in place of the goods and services tax (GST) compensation cess, effective from 1 February. Separately, it also withdrew the compensation cess on tobacco products from the same date.

The move suggests that tobacco and products will come under the new tax regime comprising excise duty, 40% GST, and the health and national security cess, as the government discontinues the existing 28% GST slab and the compensation cess on them as part of a tax restructuring.

The revamp aims to maintain tax incidence on these harmful substances largely at the current high levels, even after the GST compensation cess, which has outlived its utility, is discontinued.

The new tax regime is being implemented by way of two new laws cleared by Parliament in the winter session—Central Excise Amendment Act, 2025, and the Health Security se National Security Cess Act, 2025.

A similar order on excise duty is expected. The Central Excise (Amendment) Act, 2025, proposes raising excise duty on tobacco products. For example, the duty on tobacco would increase from 64% to 70% once implemented. Unlike cess proceeds, the Centre's tax revenue receipts such as GST, income tax and excise duty are shared with the states.

In December, finance minister Nirmala Sitharaman told Parliament that tobacco and products were not being taxed in India at World Health Organization's (WHO) benchmark taxation level.

"WHO has affordability index of tobacco products. They monitor the price range and point out where it is below the benchmark," the minister said then, adding that lower tax does not help disincentivize tobacco consumption. India's total tax incidence on tobacco is 53% of the retail price, which is substantially below the WHO benchmark of 75%, the minister said then.

Tax revenue distribution

The change in the tobacco tax regime is expected to have a direct bearing not only on overall tax revenues for the government but also on the inter se distribution between the Centre and the states, particularly with the introduction of a higher GST slab alongside excise duty and a national security and health cess, said Rajat Mohan, senior partner at AMRG & Associates.

"This 'reboot' period may see temporary volatility in pricing and margins as businesses reassess cost structures, demand sensitivity and profitability. It is therefore reasonable to expect that the industry may take some time to settle at a sustainable price point and margin profile," said Mohan.

In the absence of the National Anti-Profiteering Authority (NAA), there is an underlying expectation that producers will act responsibly and refrain from using this tax transition as an opportunity to artificially inflate prices beyond what may be warranted by the tax regime change, added Mohan.

In the case of pan masala producers, the health and national security cess will be levied on their production capacity. Under capacity-based taxation, the cess payable is calculated based on the production capacity of installed machines, rather than the actual quantity of products leaving the factory.

GST compensation cess will be discontinued from the date the Centre fully repays the ₹2.69 trillion debt it raised to support the states during the pandemic.