TaxTMI 
TaxTMI 
TaxTMI 
The indirect tax framework for tobacco products and pan masala has consistently been subject to significant tax burden by the government. It is not only a major form of revenue for the central and state government but also acts as a pillar of protection for public health. These goods are labelled as sin goods and under the new GST slabs are levied with a 40% bracket ensuring that these ‘demerited goods’ are taxed at the highest rate. Further the government has introduced further reforms to intensify the tax levy on these goods which includes the recent Central Excise (Amendment) Act, 2025 [1] and the Health Cess SE National Security Act, 2025 [2].
These new acts will change both the tax rate and issue a new valuation mechanism for levy of GST. There has been a confusion in the market as to how much the price of cigarettes and other tobacco products would rise. This article will delve upon the new tax framework for tobacco products and pan masala and show the effective tax burden for manufacturers.
Legislative Evolution: From Subsumed Taxes to Revenue Continuity
Prior to introduction of GST, the taxation of tobacco products was governed under the Central Excise Act, 1944 [3]. The tax structure involved levy based on Basic Excise Duty (‘BED’) along with special excise duty, cess [National Calamity Contingent Duty (‘NCCD’)] along with VAT at state level.
The introduction of GST forced a major overhaul of the tax system to integrate the new levy effectively. Tobacco products were categorized under the 28% slab. Further, high compensation cess had to be paid on these goods to compensate the states for the loss in revenue on account of subsuming of state taxes into GST. Along with this a nominal BED ( for example INR 5 per thousand cigarettes) was also imposed on these goods which allowed the government to also impose NCCD as an additional duty of excise as per entry 84 of list I of the Seventh Schedule to the Constitution of India, 1950.
With the GST Compensation Cess set to expire in February 2026, the government enacted the Central Excise (Amendment) Act and the Health and National Security Cess Act, 2025 to ensure revenue continuity. This new tax structure would maintain the same tax incidence even after the conclusion of compensation cess. It should be noted that the GST rate for tobacco products and pan masala has also increased from the 28% to 40% tax slab.
A Radical Transformation of Tax Incidence
The fiscal framework for tobacco products and pan masala has undergone a radical transformation. To offset the revenue gap created by the expiration of the GST Compensation Cess, the government enacted the Central Excise (Amendment) Act, 2025. While the government claimed they intended to maintain revenue neutrality, the new Act has significantly increased the total tax incidence compared to the previous regime. Following are the key structural changes:
1. The GST rate has increased from 28% to 40%
2. The period for Compensation Cess has conclude and its tax incidence has been replaced by new duties under the Central Excise Act, 1944. The earlier nominal BED has seen a massive hike. The rate of duty is currently 70% per kg for Unmanufactured Tobacco which includes highly grossing tobacco for manufacture of cigar, chewing tobacco and hookah. For various cigarettes the rate ranges from Rs 2700 per thousand to Rs 11,000 per thousand sticks based on the length of cigarettes.
3. The NCCD remains unchanged as provided under Section 136 of the Finance Act, 2001.[4]
4. A special cess under the Health Security se National Security Cess Act, 2025 is also imposed on machine or process undertaken to manufacture or produce on pan masala. The cess shall be levied based on the speed of the machine and the weight of the specified goods packed in pouch, tin or container. The cess also covers pan masala manufactured or produced without the aid of machine. This moves the taxation of pan masala to capacity based structure to prevent under reporting of sale of pan masala which was used earlier to avoid tax.
Based on this analysis, the major change is on the increase in GST rate to 40% which would certainly increase the price of these tobacco products and pan masala. It can be said that the compensation cess is replaced by the high BED under the new amendment act. However there is one more key angle to be understood as the BED has to be calculated based on the retail sale price (RSP) with abatement as provided and the taxable value for the purposes of GST would be based on the Resale Price/MRP as opposed to the earlier transaction value based calculation under Section 15(1).
The 2025 tax reforms fundamentally restructure tobacco taxation by replacing the Compensation Cess with a high-rate BED and elevating the GST slab to 40%. Changes have also been made to the valuation structure for GST purposes. The industry is being forced to pivot away from the ‘Transaction Value’ framework under Section 15(1) of the CGST Act. Under the new regime, both GST and BED are tethered to the Retail Sale Price (‘RSP’). By decoupling tax from the actual transaction price and anchoring it to the final shelf price, the government has significantly tightened the tax net. This move significantly tightens the tax incidence as the actual taxable value for manufacturers would be much higher in RSP structure.
The Pivot to RSP-Based Valuation
Earlier the valuation of tobacco products was based on ‘transaction value’ as determined under Section 15(1) of the CGST Act. With the introduction of Rule 31D as per Central Goods and Services Tax (Fifth Amendment) Rules, 2025,[5] tobacco products would be taxed based on RSP or Maximum Retail Price (‘MRP’) printed on the packaged product.
RSP has been defined under Rule 31D as maximum price that is printed on the package based on which the goods is sold to the ultimate consumer. The value of supply for GST is now the RSP minus the taxes already included in that price as the RSP already includes the tax and calculating tax on MRP would result in taxing the tax itself, hence the rule provides for a formula to calculate the GST amount.
Tax amount= (Retail sale price X tax rate in % of applicable taxes) / (100+ sum of applicable tax rate)
For example, the MRP of a packet of pan masala is Rs 20. The GST that would be paid on this packet by the manufacturer would be 20 X 40% / 100 + 20 = 6.6 Rs of GST. In the previous system the GST rate was also low (28%) and the manufacturer would sell the packets to the distributors at a fake low price to avoid higher taxation. This has front-loaded the entire tax collection at the factory gate, ensuring that not a single rupee of the final retail value escapes the 40% GST net.
It should be noted that Rule 31D effectively ends the system of discounts. Earlier the wholesalers used to provide discounts to clear stock which would also help lower gst burden. But now they have to account for GST based on the printed MRP. This moulds the soul of GST from a consumption based tax to a fixed rate manufacturing tax making the amendment vulnerable to constitutional challenge.
A significant technical vulnerability lies in the mandatory link between Rule 31D and the Legal Metrology Act. Because the new valuation rule is triggered only by a declared RSP, any supply exempt from MRP-printing requirements such as institutional or industrial bulk sales falls outside its scope. In such cases, the tax base reverts to the Transaction Value (Section 15(1)), potentially providing a loophole to supplier of unmanufactured tobacco when they only supply raw materials.
Conclusion: Preparing for a High-Tax Future
With the new legislations in place from February 2026, the tobacco and pan masala industry must get ready to face increased tax burden. Even though compensation cess is replaced by the new BED rates, the new tax slab of 40% and the RSP based valuation structure would be the major cause for higher tax burden for this industry. The ultimate effect would be on the consumers as they have to bear the burden of these new changes. Pan masala firms would face an even higher tax incidence due to the new cess levied on capacity based operation. Businesses should be ready to undertake a critical analysis of their finances and consumers should be ready to pay an even higher price for their sin products.
[1]The Central Excise (Amendment) Act, 2025, No. 34 of 2025.
[2]The Health Security Se National Security Cess Act, 2025, No. 35 Of 2025.
[3]The Central Excise Act, 1944, no. 1 of 1944.
[4] MoneyControl News, NCCD would continue at existing rates, clarify FinMin sources on excise duty on cigarettes, January 02, 2026, https://www.moneycontrol.com/news/business/nccd-would-continue-at-existing-rates-clarify-finmin-sources-on-excise-duty-on-cigarettes-13753980.html.
[5]Notification no. 19/2025 – Central Tax, 31st December 2025,