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Background & Rationale

The Goods and Services Tax (GST), introduced in 2017, marked a significant reform in India’s indirect taxation system by subsuming multiple central and state levies into a unified framework. However, the GST structure was designed with multiple rate slabs – 0%, 5%, 12%, 18%, and 28%, along with certain special rates such as 3% for specific goods and services.

Over time, this multi-tiered rate system led to several operational and structural challenges- the existence of multiple slabs created complexities in classification, compliance, and administration. Additionally, certain sectors experienced inverted duty structures, where input goods were taxed at higher rates than the final output tax, resulting in the accumulation of unutilized input tax credits. These distortions contributed to compliance burdens, cash flow constraints, and demand suppression in several segments of the economy.

Recognising these issues, the government and the GST Council initiated discussions to simplify and rationalise the tax structure. The objective was to stimulate demand, reduce compliance costs, and create a more uniform and predictable tax environment. These efforts culminated in a comprehensive set of reforms – widely referred to as “GST 2.0” or the next-generation GST reforms.

On 3^rd September 2025, the GST Council approved sweeping changes aimed at addressing the structural inefficiencies of the earlier framework. These reforms officially came into effect from 22 September 2025, with a few provisions scheduled for staggered implementation based on sectoral readiness and transitional considerations.

Key Changes / Reforms in 2025

1. Simplified Slab Structure & New Rates

One of the most significant aspects of the 2025 GST reforms is the rationalisation of tax slabs, aimed at simplifying the rate structure and reducing classification disputes. The earlier framework with five primary slabs (0%, 5%, 12%, 18%, and 28%) and several special rates has now been streamlined to focus on three core rates, supported by a limited number of special and demerit rates.

The new regime is structured as follows:

• 0% (Exempt / Nil Rate): Applicable to necessities, essential food items, select medicines, and healthcare-related goods and services.
• 5% (Merit / Concessional Rate): Covers a wide range of essential commodities, agricultural inputs, and common-use items that have a direct impact on household consumption and inflation.
• 18% (Standard Rate): Represents the core rate for most goods and services across industries, providing a unified and simplified tax environment for businesses and consumers alike.
• 40% (Demerit / Sin / Luxury Rate): Levied on a limited category of goods such as tobacco products, certain beverages, high-end automobiles, and luxury or sin goods. The implementation of this slab, however, is contingent on the settlement of outstanding GST compensation cess liabilities and may therefore be phased in gradually.

Certain items—such as Gold, Silver, and Precious Metals continue to attract special rates (e.g., 3%) under the residual category, maintaining parity with international taxation norms and sectoral sensitivities.

In essence, the system transitions from a multi-tier structure to a more consolidated framework centred around 5% and 18%, with 0% and 40% serving as the outer boundaries. This simplification is expected to enhance compliance, reduce disputes, and make the GST structure more predictable and business-friendly.

2. Sectoral / Item-level Changes & Reclassifications

To implement the slab rationalisation, many goods and services have been reclassified:

• Essentials and Daily-Use Goods: A broad range of essential and mass-consumption products, such as dairy items, packaged foods, and everyday household goods, have seen significant rate reductions. Many of these products, earlier taxed at 12% or 18%, have now been brought under the 5% or even 0% category, thereby easing inflationary pressures and improving consumer affordability.
• Health, Insurance, and Life-Saving Goods: Major reforms have been introduced in the healthcare and insurance segments. Individual health and life insurance policies are now exempt (0%), compared to the earlier 18% rate.Around 33 critical life-saving and essential medicines have been shifted to the 0% / exempt category, making healthcare more affordable and accessible.
• Automobiles and Vehicles: In a significant relief to the automobile industry, small and mid-segment cars, two-wheelers, and standard vehicles have seen their GST rates reduced from 28% to 18%. This move aims to stimulate demand, support automotive manufacturing, and enhance overall sectoral competitiveness.
• Sin and Luxury Goods: To maintain progressivity in the tax regime, tobacco, pan masala, aerated beverages, and luxury items have been moved to the newly introduced 40% slab. This ensures revenue neutrality while discouraging consumption of non-essential or harmful products.
• Electronics, Appliances, and Durable Goods: Several consumer durables and electronic items previously under the 28% slab have now been reclassified to 18%. Products such as televisions, air conditioners, refrigerators, and kitchen appliances are among the key beneficiaries of this rate cut. The reform is expected to boost demand in the consumer electronics and durable goods sectors, supporting domestic manufacturing and retail growth.
• Footwear and Leather Products: The GST rate on footwear and leather goods has been reduced from 12% to 5%, particularly for footwear priced up to ₹2,500 per pair. This move provides relief to both consumers and small and medium-scale manufacturers, especially those in traditional clusters.
• Wood and Eco-Friendly Products: In alignment with the government’s focus on sustainability and green manufacturing, items such as particle boards, bamboo flooring, and other eco-products have been moved to the 5% slab. This is expected to encourage the adoption of environmentally friendly materials in construction and home decor.
• Mining and Coal: Some mining-related inputs and coal products, previously taxed at 5%, may witness an upward revision to 18%. This realignment seeks to correct inverted duty structures and rationalise input credit accumulation in the energy and mining sectors.

3. Other Structural / Procedural Reforms

Beyond rate rationalisation, the 2025 GST reforms encompass several structural and procedural enhancements designed to make the tax system more efficient, transparent, and business-friendly. These measures aim to address long-standing administrative challenges and strengthen the overall architecture of GST 2.0.

• Faster Refunds and Ease of Compliance: The reformed framework emphasises automation and timeliness in the refund and return processes. Businesses can expect quicker processing of refunds, supported by AI-driven verification, auto-matching of input credits, and reduced manual intervention. The move towards paperless compliance, simplified filing systems, and pre-filled return formats seeks to minimise human errors and lower compliance costs, particularly for MSMEs and exporters.

• Phasing Out of Compensation Cess: The compensation cess, originally introduced to compensate states for revenue shortfalls during the transition to GST, is set to be gradually phased out or rationalised. With revenue stabilisation expected under the new rate regime, the dependence on cess collections will diminish. The phasing-out plan is aligned to move towards a cleaner, single-rate system over the medium term.

• Fitment Committees and Continuous Rate Review: To ensure ongoing refinement of the tax structure, fitment committees have been empowered to periodically review and recommend adjustments to GST rates. These committees will address inverted duty structures, classification disputes, and emerging sectoral demands. This dynamic approach will help maintain equity, efficiency, and competitiveness across industries.

• Staged Implementation of Select Reforms: Recognising the magnitude of change, certain provisions, especially the 40% slab for demerit and luxury goods, are planned for staggered implementation. The rollout will depend on the settlement of compensation cess obligations, fiscal conditions, and the readiness of administrative systems. This phased approach ensures a smooth transition and avoids disruption to revenue or supply chains.

• Transitional and Legacy Provisions: To facilitate seamless migration to the new structure, detailed transitional guidelines have been issued. These cover inventory in the supply chain, packaging and labelling adjustments, and input tax credit treatment for goods manufactured before 22 September 2025 but sold thereafter. Such measures are intended to provide clarity and operational continuity for taxpayers during the transition phase.

Conclusion: The Maturation of India’s Indirect Tax Revolution

The transition to GST 2.0 marks the maturation of India’s tax reform, moving beyond initial adoption toward full systemic efficiency. The critical transformation is the shift from manual compliance to a Regulatory-Tech-enabled ecosystem, where AI and comprehensive e-invoicing drastically tighten the tax net and combat evasion. By enforcing strict discipline across the value chain and addressing persistent issues like litigation and the exclusion of key sectors like fuel and alcohol, India is poised to realise a truly unified, efficient, and equitable common market. GST 2.0 ensures that the framework becomes a cornerstone of sustainable national economic growth.

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.

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