Rav Singh

Winnings from Online Games: CBDT Clarifies Contours of Section 194BA, IT Act, 1961

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Finance Act, 2023 inter alia introduced changes to withholding tax obligations for winnings from lottery, crossword puzzles and horse races under Sections 194B and 194BB, IT Act, 1961. Finance Act, 2023 also introduced a new provision, i.e., Section 194BA, IT Act, 1961 to deduct taxes on winnings from online games apart from introducing a new charging provision, i.e., Section 115BBJ for such winnings. The Central Board of Direct Taxes (‘CBDT’), on 22 May 2023 issued a Circular[1] containing Guidelines for implementation of Section 194BA. This post is an attempt to examine the above mentioned changes and highlight how winnings from online games are being categorized separately under the IT Act, 1961.   

Changes Introduced by the Finance Act, 2023 

Prior to Finance Act, 2023, Section 194B, IT Act, 1961 provided that the person responsible for paying to any person any income by way of winnings from any lottery or crossword puzzle or card game and other games of any sort in an amount exceeding ten thousand rupees shall at the time of payment thereof, deduct income tax at the rates in force. Section 194BB imposed a similar obligation on the person responsible for making a payment of any income by way of winnings from any horse race or from wagering or betting in any horse race.  

The Finance Act, 2023 amended both the above provisions to clarify that the deduction of tax under the aforesaid provisions shall be on the amount or aggregate of amounts exceeding ten thousand rupees during the financial year. The State claimed that the deductors under Section 194B and Section 194BB were splitting winnings into various transactions below Rs 10,000 – presumably to avoid withholding tax obligations under Section 194B and Section 194BB – which was contrary to legislative intent and the amendments were an attempt to plug this loophole. 

Equally, Section 194B was amended to include ‘gambling or betting of any form or nature whatsoever’ but exclude online games from its purview. A new provision, i.e., Section 194BA was introduced to govern deduction of taxes on winnings from online games and which provides that taxes shall be deducted on net winnings in the user account at the end of the financial year. Simultaneously, a separate charging provision for winnings from online games was introduced, i.e., Section 115BBJ, IT Act, 1961 while winnings from other games continued be charged under Section 115BB. 

The cumulative effect of the above changes introduced by the Finance Act, 2023 is that withholding tax obligations and tax liabilities of winnings from online games have their own specific provisions – Section 194BA and Section 115BBJ, IT Act, 1961 – and will not be governed by generic provisions relating to winnings from games.     

Clarifications Issued Via the CBDT Circular  

On 22 May 2023, Central Board of Direct Taxes (‘CBDT’) issued guidelines in exercise of its powers under the newly inserted Section 194BA, IT Act, 1961. Simultaneously, Rule 133 was added to the Income Tax Rules, 1962 which prescribed a relatively straightforward formula to calculate net winnings under Section 115BBJ, IT Act, 1961. 

The CBDT Guidelines are meant to clarify certain aspects of the deductor’s obligations under Section 194BA. For example, the Guidelines state that a user account shall mean every account of the user, by whatever name called, which is registered with the online gaming intermediary. Further, that where a user has multiple user accounts on different platforms of a single deductor then each user account shall be considered on an aggregate except where such aggregation is not possible due to technological reasons. There are a few other clarifications; however, in my view, to understand the contours of the Section 194BA, IT Act, 1961 four aspects of the Guidelines are vital:

First, any bonus, winnings, incentives provided to players would be considered as part of net winnings and liable to deducted under Section 194BA. Except when such bonus is credited in the user account only for playing and cannot be used for any purpose then it will not be considered as part of net winnings. Further, if the latter is recharacterized and allowed to be withdrawn then they shall be treated as taxable deposit at the time of their characterization. Determining the time of characterization may not prove to be straightforward. Will it be the date the winner is informed or the date the winner can withdraw the bonus?   

Second, Section 194BA(2) provides where winnings are partly in kind and partly in cash, but the cash component is not sufficient to meet the withholding liability, then payer responsible for paying shall ensure that the tax has been paid in respect of the net winnings. The Guidelines add that the net winnings shall be released only after the deductee has provided proof of payment of tax. But then it curiously adds that the deductor to avoid difficulty may deduct the tax under Section 194BA and pay to the Government. But, if cash component is not sufficient to deduct the tax, how will the tax deduction take place? 

Third, an issue that is likely to be confusing under this provision is when winnings are in kind. While their valuation will be as per their fair market value, a concept that has been long recognized by the IT Act, 1961. But, where money in user account is used to buy something in kind then it will be considered as ‘net winnings in cash’ and deductor is required to deduct tax at source. Guidelines are not entirely clear on how deductor/payer will compute withholding tax liability in this scenario.      

Fourth, the Guidelines clarify that Section 194BA does not apply to insignificant amounts, i.e., where the net winnings in the amount withdrawn do not exceed Rs 100 a month. But tax needs to be deducted when net winnings cross Rs 100 in the same month or subsequent month. And the deductor ‘undertakes responsibility of paying the difference’ if the balance in the user account is not sufficient at the time of deduction. The minimum threshold of Rs 100 in net winnings is thus not a simple exemption but requires the deductor to be careful when and how to deduct tax, else the deductor becomes liable for the amount that escapes tax. 

The Guidelines offer clarity on a few other aspects and seem comprehensive and well-drafted to provide sufficient information to deductors – in this case online game intermediaries – about their tax withholding liabilities under the new provision. 

There are only two major areas of concern regarding Section 194BA read with its Guidelines: first, that the threshold limit is too low implying that the withholding liability of deductors is likely to be triggered for a large no. of transactions on their platforms significantly adding to their tax compliance burden; second, in case of winnings involving cash and kind, the withholding tax obligations of the deductor are not straightforward and may cause confusion.       

Conclusion  

It is obvious that via the Finance Act, 2023 an attempt has been made to create a distinct tax regime for winnings from online games under the IT Act, 1961. Prima facie, there is nothing qualitatively different about the nature of winnings from offline games vis-à-vis online games. Further, the tax obligations/tax rates also for winnings from online vis-à-vis offline games do not differ to require standalone provisions for online games. However, the State seems to think differently. As explained: 

There is a need to bring in specific provisions regarding TDS and taxability of online games due to its different nature, being easily accessible vide the Internet and computer resources with a variety of playing options and payment options. (Explanatory Memorandum to Finance Bill, 2023, page 27) (emphasis added)

Currently, we do not know the fully import of the phrase ‘different nature’. While the variety of payment options, recent popularity of online games played may have motivated the State to create a separate set of tax provisions for their winnings. It remains to be seen if the justification for a different set of provisions is borne out once these provisions are implemented.   

[1] https://incometaxindia.gov.in/pages/communications/index.aspx (Accessed on 23.05.2023). 

Revenue Misinterprets Jurisprudence on Game of Skill: Kar HC Introduces Sanity Through Gameskraft Judgment

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On 11 May 2023, a Single Judge Bench of the Karnataka High Court delivered a judgment in the Gameskraftcase[1] deciding that the actions of the Revenue Department against online intermediary company, M/s Gameskraft Technologies Pvt Ltd (‘GTPL’) had no basis in law. The Revenue Department inter alia has issued an intimation notice under Section 74(5), CGST Act, 2017 calling GTPL to deposit Rs 21,000 crores (appx) along with penalty and interest. The impugned intimation notice, and the subsequent show cause notice issued under Section 74(1), CGST Act, 2017 were the subject of the dispute. 

Before I delve into the judgment, I think it is worth clarifying that the gambling law jurisprudence in India divides games into games of skill and games of chance. The latter are typically understood to be synonyms of gambling/betting. And if a game has elements of both skill and chance, then the predominant element decides the nature of the game, e.g., a game which is predominantly skill-based is understood to be a game of skill while a game which is predominantly game of chance is classified as a game of chance.    

Core Issue 

GTPL’s/Petitioner’s main argument was that they are not involved in ‘betting/gambling’. While the petitioners relied on various judgments to support their two claims, their claim is best understood through description of their business model. The petitioners claimed that they operated a platform and acted as an intermediary for players to play a game of rummy. For example, two players ‘A’ and ‘B’ intending to play rummy would download their mobile application. Both players would deposit Rs 200 each, and the petitioner for facilitating and hosting the game would charge Rs 20 each from both the players and keep the remaining Rs 360 in trust. At the end of the game, the petitioner would disburse Rs 360 to the winner. The petitioner claimed that it had no lien or right over the prize money of Rs 360. Its revenue from the above transaction was only Rs 40 on which it paid GST. 

Petitioners claimed that the ‘buy-in’ amount or gross transaction money facilitated through their platform – which in the above example was Rs 400 – could not be treated as their revenue. The amount belonged to the players, and petitioners had no lien or right over the said amount, which in this case the Revenue Department alleged was Rs 70,000 crores. And presumably the gross transaction amount was the basis of GST demand of Rs 21,000 crores.      

Petitioners further claimed that they were not involved in supply of actionable claims. And that actionable claims if any were between the players which was also irrelevant because actionable claims were exempt from GST. Schedule III of the CGST Act, 2017 lists activities or transactions which shall be treated as neither supply of goods nor supply of services. Entry 6 of Schedule III states as follows: 

            Actionable claims, other than lottery, betting and gambling. 

Thus, actionable claims unless they are lottery, betting and gambling are outside the purview of GST. And the petitioners claimed that neither are they involved in supply of actionable claims nor are the games on their platform, specifically rummy, captured by ‘lottery, betting and gambling’ since rummy is a game of skill and not a game of chance.  

The petitioners relied on the decades old Indian jurisprudence that has clearly held rummy to be a game of skill. And petitioners argued that playing rummy online does not impart it the character of a game of chance and neither does playing rummy with stakes change its character from a game of skill to a game of chance. 

Revenue Department Makes Incredulous Arguments 

As is evident from the preceding discussion, the Revenue Department’s claim that the petitioner’s activities were subject to GST would have only succeeded if they could prove that the petitioners supplied actionable claims in the form of lottery, betting and gambling. And since it was the game of rummy in question, they had to establish that the game of rummy played online and with stakes would amount to a game of chance for it to be included in the phrase ‘lottery, betting and gambling’. To establish its case, the Revenue Department indulged in an exercise of selective, non-contextual and self-serving interpretation of relevant precedents. The Revenue Department made various far-fetched arguments, and to highlight its approach, I will elaborate on its two central claims, i.e., a game of skill when played with stakes transforms into a game of chance. In this case, it meant that rummy, a game held to be a game of skill, should be viewed as a game of chance since the players involved placed stakes on the game. Further, the commission charged by the petitioners should not be viewed as a commission but earning profits and gains from stakes because their commission amount varied depending on the stakes placed on the game and was not an across the board charge.      

The Revenue made bizzare claims based on their incorrect interpretation of the jurisprudence on game of skill and game of chance. To begin with, they denied that rummy was a game of skill, contrary to well-established jurisprudence[2] that stated otherwise. Instead, they quoted selective paragraphs out of context to back their incredulous claim.

The High Court was not swayed by the Revenue Department’s fanciful interpretive exercise and instead reiterated that rummy is a game of skill ‘where predominantly skill is exercised to control the outcome of the game.’ (para 5) It added that a playing rummy with stakes does not make it a wagering contract, since a wager requires that the person placing the wager should have no interest in the outcome of a game while a player is clearly interested in winning the game. The High Court stated that: 

The game of rummy played with stakes is played between players on the basis of the assessment of their own skill. Therefore, while playing for stakes, the player makes a value judgment on his/her skill. The outcome of the game is determined predominantly by the skill of the players. Therefore, rummy played with stakes same cannot be viewed as a ‘forecast’ or a shot at the “hidden target”. (para 11)

The Revenue relied on the Satyanarayana case to argue that petitioner’s earning commission fee for facilitating rummy with stakes on its platform amounted to facilitating gambling and running a gaming house. Satyanarayana case had clearly held that rummy is a game of skill even if played with stakes. The Supreme Court had added that if there is evidence of gambling or owner of house or club was making a profit or gain from rummy, the offence of running a gaming house could be established. The Karnataka High Court correctly read the ratio of Saynarayana case to hold that charging a sitting fees is not profit in context of a common gaming house and that organizer of a skill-based game is not prohibited from charging a fee from the players of the game. (para 5 and 7). Accordingly, petitioners making profits and gains from rummy played on their platform cannot be accused of running a common gaming house. The High Court concluded that: 

Irrespective of who wins, the Petitioners, in terms of its contract with the players, collects a percentage of the amounts staked as its platform fees / commission for providing its services as an intermediary. Thus, the Respondents cannot be permitted to supply words to these observations and say that placing of stakes on a game of skill amounts to gambling. In any event, from a reading of the whole judgment, it is evident that this last line is not the ratio of the judgment at all. (para 10)  

The edifice of the Revenue’s case collapsed with the Karnataka High Court rejecting its above two arguments. The High Court concluded that all the issues raised and argued were covered by Supreme Court’s judgment in All India Gaming Federation case[3], i.e., whether played physically or online, with or without stakes, game of skill does not lose its character and is determined by applying the predominance test. 

Karnataka High Court Dismisses the Revenue’s Case  

The Karnataka High Court combed through practically the entire post-Independence jurisprudence on game of skill v/s game of chance, cited the precedents copiously, highlighted relevant paragraphs of the ratio to emphasise that the context and meaning of the judgments was opposite to the Revenue Department’s arguments. The High Court concluded that the Revenue Department’s case was based on fragile footing and observed:  

After having dealt with the rival contentions as stated supra, it is significant to state that a perusal of the impugned show cause notice as well as contentions and submissions of the respondents will clearly indicate that the same are an outcome of a vain and futile attempt on the part of the respondents to cherry pick stray sentences from the judgments of various Courts including the Apex Court, this Court and other High Courts and try to build up a non-existent case out of nothing which clearly amounts to splitting hairs and clutching at straws which cannot be countenanced and is impermissible in law. (emphasis added) (para 7)

Accordingly, the High Court held that there is no difference between online and offline games of rummy and rummy does not become a game of chance if played with stakes. It held that Entry 6, Schedule III of CGST Act, 2017 was not applicable to only rummy played with or without stakes or any games which is preponderantly a game of skill and thus petitioner’s platforms were not taxable as ‘betting and gambling’ as contended by the Revenue Department. The show cause notice issued to petitioner’s was quashed for being illegal, arbitrary and without jurisdiction or authority of law.    

Way Forward 

The Revenue Department has made repeated claims that online gaming companies indulge in significant tax evasion. The credibility of tax evasion claims has not been established through actual numbers and neither has any evidence been shared publicly. But, CGST Act, 2017 and the IT Act, 1961 empower the Revenue Department sufficiently to tackle tax evasion and build a case of contravention of tax laws. 

However, after reading the Gameskraft judgment, the picture that emerges is that the Revenue Department had pre-determined that the online gaming platforms facilitate games of chance/gambling and earn the entire amount of transactions undertaken through them. And every argument was then moulded and force-fitted to reinforce the initial conclusion. The Karnataka High Court saw through the Revenue Department’s exercise and correctly chided it for indulging in such an exercise. In fact, so far-fetched was the Revenue Department’s claim that the High Court could have just referred to its previous decision in All India Gaming Federation caseand dismissed the Revenue Department’s claims. However, the detailed 325 page decision in this case might act as a deterrence for the Revenue Department since its central premise has been outrightly, painstakingly and comprehensively dismissed by the High Court by citing every major case on gambling law in detail. Whether the Karnataka High Court’s decision would deter the Revenue Department in any manner is tough to predict; but, if past is any indication the Revenue Department is likely to treat it as a minor hiccup in its pursuit of revenue, come hell or high water. 

[1] Gameskraft Technologies Pvt Ltd v DGGSTI 2023 SCC OnLine Kar 18. 

[2] State of Andhra Pradesh v K. Satyanarayana & Ors AIR 1968 SC 825, at para 12. 

[3] All India Gaming Federation v State of Karnataka & Ors AIR 2022 SCC OnLine Kar 435. 

Refunds for Zero-Rated Exports Viewed as Fundamental to GST Regime

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In a judgment pronounced on 16 February 2023, a Single Judge Bench of the Karnataka High Court in Tonbo Imaging India case[1] held that Rule 89(4)(C), CGST Rules, 2017 ‘is illegal, arbitrary, unreasonable, irrational, unfair, unjust and ultra vires Section 16 of the IGST Act and Section 54 of the CGST Act …’. (para 17) The writ petition filed by the petitioners challenged that the amendment to Rule 89(4)(C) – via Notification 16/2020-CT dated 23.03.2020 – was unconstitutional and the High Court upheld the same. I explore the arguments and the High Court’s reasoning in this post.  

Background to the Writ Petition  

The petitioners were engaged in designing, developing, and deploying various types of advanced imaging and sensor systems to control and understand complex environments. The petitioners exported the aforementioned products from May 2018 to March 2019. Accordingly, the petitioners claimed refunds of its zero-rated exports under Section 16, IGST Act, 2017 read with Section 54(3)(i), CGST Act, 2017 and Rule 89, CGST Rules, 2017. The petitioners claim was rejected by the Revenue Department for not filing proof as required under the amended Rule 89(4)(C) despite the petitioner contending that their case related to the period before the amendment and should be governed by the pre-amended rule. The petitioner argued that its case should be governed by the pre-amended version of Rule 89(4)(C) which stated as follows:

Turnover of zero-rated supply of goods means the value of zero-rated supply of goods made during the relevant period without payment of tax under bond or letter of undertaking as declared by the supplier, whichever is less, other than the turnover of supplies in respect of which refund is claimed under sub-rules (4A) or (4B) or both.

While the Revenue Department’s case was that the petitioner must show proof as required under the amended version of Rule 89(4)(C), which states as follows: 

Turnover of zero-rated supply of goods means the value of zero-rated supply of goods made during the relevant period without payment of tax under bond or letter of undertaking or the value which is 1.5 times the value of like goods domestically supplied by the same or, similarly placed supplier, as declared by the supplier, whichever is less, other than the turnover of supplies in respect of which refund is claimed under sub-rules (4A) or (4B) or both. (emphasis added)

The amended rule introduced the concept of comparing the value of exports of the supplier with its domestic supplies, and introducing an upper cap to the refunds based on the comparison. This would mean that if an exporter has paid a certain amount by way of GST on its purchases, then the Revenue Department may not refund the entire tax amount but only 1.5 times the value of like goods supplied domestically. 

Petitioner’s Arguments

The petitioner assailed the amendment to Rule 89(4)(C) on various grounds. First, that while Section 16(3) allowed refund of taxes made in the course of making a zero-rated supply, the Rule in whittling the refund is ultra vires the parent statute. Second, the petitioners claimed that the amendment to Rule 89(4)(C) creates a hostile discrimination between exporters who export without payment of duty under a Bond/Letter of Undertaking and those who pay duty. And only exporters who made exports without payment of duty were subjected to the restriction under Rule 89(4)(C). Extending the Article 14 argument, the petitioners argued that the impugned Rule was arbitrary and unreasonable because it had no rational nexus with the objective sought to be achieved by Section 16, IGST Act, 2017, i.e., zero-rating of exports. Third, the petitioners argued that amendment to the impugned Rule was violative of Article 19(1)(g) since it will affect availability of funds and hamper the rotation of their funds. Finally, the petitioners assailed the impugned Rule on the ground that it suffered from the vice of vagueness, did not define key terms nor did it prescribe the consequences if a similarly placed supplier was not found or the supplier did not supply similar goods domestically.       

High Court Accepts Petitioner’s Arguments 

The Karnataka High Court accepted almost all the petitioner’s arguments. It traced a brief legislative history of GST to conclude that zero-rating of exports was a core feature of GST in Section 16, IGST Act, 2017 and Section 54, CGST Act, 2017 with Rule 89 as a machinery provision to implement the policy of zero-rating. Based on this understanding, the High Court almost repeated all of the petitioner’s arguments approvingly. 

The High Court held that the amended Rule 89(4)(C) overrides the parent legislation since it restricts refunds while the parent provisions, i.e., Section 16, IGST Act, 2017 and Section 54, CGST Act, 2017, allow for full refunds for zero-rated supplies such as exports. It accepted the argument that the impugned Rule created hostile discrimination between two kinds of exporters, i.e., those who export without payment of duty and those who pay duty violating Article 14; especially since there was no rational nexus with the objective contained in Section 16, IGST Act, 2017. The High Court also opined that the impugned Rule was unreasonable since it affected the availability of funds and caused hardship to exporters. Further, it held the impugned Rule to be vague as phrases such as ‘like goods’ and ‘similarly placed supplier’ were not defined in the statute or relevant Rules. It concluded that:  

The object of zero rating would be lost if exports are made to suffer GST as the exporter would either pass it on to the foreign supplier or would absorb it himself; firstly it would mean that taxes are exported which is against the policy of zero rating supra and secondly, it would make exports uncompetitive being against the stated policy of the Government. The amending words therefore, do not sub serve the objectives set out in Section 16 of the IGST Act, 2017 nor Section 54 of the CGST Act, 2017 and are contrary to the clarifications given above. (Para 17(h))

The High Court viewed the impugned Rule at odds with the GST’s objective of making exports zero-rated and not subjecting them to the burden of tax. Zero-rating of goods is also in consonance with GST’s identity as a destination-based tax. The State had to discharge a heavy burden in arguing the reason for the departure from the core characteristics and policy of GST. However, no persuasive reason was argued by the State.  

Conclusion

The judgment is a closely reasoned judgment and supports its conclusions adequately. The entire premise of the judgment is that zero-rating of exports is a core feature of GST encoded in the legislation, and deviation from its via secondary legislation without a persuasive reason is impermissible. However, the judgment offers no perspective from the State and/or the Revenue Department. The Karnataka High Court never elaborated on the State’s arguments because considered them to be ‘neither relevant nor germane’ for adjudication of the petition. (para 27) Only argument of the State, i.e., the impugned Rule was amended to prevent misuse was referred to dismissed summarily. The High Court rightly held that in the absence of defining data the reason of misuse has no reasonable basis in law and neither can amendments to law be made on the premise of distrust without actually ascertaining the misuse. (para 22) Apart from the above, no detailed reference is made to the State’s arguments. Consequently, we never really get an insight as to why the amendment to Rule 89(4)(C) was made and the objective sought to be achieved by restricting refunds of exporters. And, at the time of writing, there seems to be no move to challenge this judgment either.    

[1] M/s Tonbo Imaging India Pvt Ltd v Union of India 2023 LiveLaw (Kar) 134. 

Supreme Court Interprets Section 153A, IT Act, 1961 Correctly & Provides ‘Remedy’ to the Revenue  

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Introduction 

On 24 April 2023, a Division Bench of the Supreme Court in Abhisar Buildwell case[1] interpreted the scope of Section 153A, IT Act, 1961. The specific question before the Supreme Court was: whether the jurisdiction of Assessing Officer to make assessment in respect of completed/unabated assessment is confined only to incriminating material found during a search or requisition under Sections 132 and 132A? The Supreme Court – relying on the Delhi High Court’s judgment – narrowly interpreted the Assessing Officer’s jurisdiction and answered the above question in the affirmative. The Supreme Court held that the Assessing Officer could not make additions to the completed assessment based on other material on record if no incriminating material was found during the search or requisition.     

Arguments About the Scope of Section 153A

To begin with, it is important to understand the elements of Section 153A, IT Act, 1961 which required consideration by the Supreme Court.  

Section 153A(1) states that in case of a person where a search is initiated under Section 132 or books of account, other documents or any assets are requisitioned under Section 132A, the Assessing Officer shall issue a notice to the person requiring him to furnish a return for the six assessment years immediately preceding the preceding year in which the search is conducted or requisition is made. And the Assessing Officer shall assess or reassess the total income in respect of each assessment year falling within such six assessment years. 

The Second Proviso, is worth citing in full: 

Provided further that assessment or reassessment, if any, relating to any assessment year falling within the period of six assessment years and for the relevant assessment year or years referred to in this sub-section pending on the date of initiation of the search under section 132 or making of requisition under section 132A, as the case may be, shall abate :   (emphasis added)

The Second Proviso cited above mentions that only the pending assessments or reassessments on the date of initiation of search or requisition shall stand abated. 

The State contended that even if no incriminating material is found during the search or requisition then additions to completed assessments could also be made by the Assessing Officer in respect of other material on record. The primary basis of the State’s argument was that the mandate of the Assessing Officer under Section 153A is with respect to ‘total income’ read with Section 4, IT Act, 1961, i.e., the charging provision under the statute which provides for assessment of total income. And if the Assessing Officer is allowed to only assess ‘partial income’ it would not be in accordance with the IT Act, 1961. Accordingly, the State argued that the Assessing Officer is authorized to make additions to completed assessments based on other material even if no new material was found during the search or requisition.  

The assessees, on the other hand, argued for a contextual interpretation of the term ‘income’ and Section 153A, IT Act, 1961. The assesses argued that the purpose of Section 153A is to discover information through search or requisition which could not ordinarily discovered. And, if no incriminating material is found after such search or requisition there is no justification for opening completed assessments by using other material on record. The assessees also had the strength of various High Court judgments which had taken a similar view.        

Delhi High Court’s Interpretation Approved by the Supreme Court

Various High Courts had expressed differing opinions on the issue before the Supreme Court. One such judgment which was the subject of appeal was the Delhi High Court’s judgment in Kabul Chawla case.[2] The Delhi High Court through a well-reasoned judgment in Kabul Chawla case, had laid down the scope of Section 153A in clear terms. The High Court had observed that once search under Section 132 takes place, a notice is mandatorily issued to the person requiring him to file returns for six assessment years preceding the previous year. And the Assessing Officer has the power to assess or reassess the total income for each of the said six years in separate assessment orders for six years. It added that while Section 153A does not expressly state that additions to assessment should be strictly based on evidence found during search, it does not mean that assessment ‘can be arbitrary or made without any relevance or nexus with the seized material. Obviously an assessment has to be made under this Section only on the basis of seized material.’ (para 37) The Delhi High Court had clarified that in the absence of any incriminating material, the abated/completed assessment can be reiterated and the abated assessment or reassessment can be made under Section 153A. 

The Delhi High Court had made it amply clear that completed assessments could be interfered by the Assessing Officer under Section 153A only on the basis of incriminating material found during search or requisition and not by relying on material already disclosed or known in the course of original assessment. 

The Supreme Court expressed ‘complete agreement’ with the observations of the Delhi High Court. (para 8) In doing so, the Supreme Court added its own reasons:  

First, it adopted a purposive interpretation of Section 153A to observe that the very purpose of search and seizure – which triggers Section 153A – is detection of undisclosed income through extraordinary powers. Thus, the foundation for search assessments under Section 153A is incriminating material discovered during such search or seizure.  

Second, it again referred to legislative intent behind the Second Proviso and observed that only pending assessments/reassessments for the six assessment years abate on initiation of search or requisition. Also referred to Section 153A(2) which states that if any proceeding or any order of assessment or reassessment under Section 153A(1) is annulled in appeal or any legal proceeding, then the assessment or reassessment which abated under the Second Proviso shall revive. Referring to the afore-stated provisions, it observed ‘the intention does not seem to be to re-open the completed/unabated assessments, unless any incriminating material is found with respect to concerned assessment year falling within last six years preceding the search.’ (para 11)  

Third, it stated that if the Revenue Department’s argument that completed assessments can be re-opened even if no incriminating material is found during the search or seizure, is accepted it would lead to two assessments order which was impermissible under the law and would make the Second Proviso redundant. This observation is pertinent because Section 153A replaced the previous provision Section 158BA to do away with the concept of parallel assessments for undisclosed income. And, under Section 153A the undisclosed income is taxed at the same rate as the rest of income, as opposed to the previous regime where undisclosed income was tax at a higher rate thereby necessitating two assessments. And IT Act, 1961 no longer recognises the concept of parallel assessments.     

‘Remedy’ to the Revenue 

The Delhi High Court’s interpretation of Section 153A, IT Act, 1961 was supported by adequate and articulate reasoning and the Supreme Court’s decision to that extent was also well-reasoned. The Supreme Court, however, made another observation that ‘the Revenue cannot be left with no remedy.’ (para 11) The Supreme Court added that even in case of block assessments under Section 153A where no incriminating material is found during a search, ‘the power of the Revenue to have the reassessment under section 147/148 of the Act has to be saved ..’. (para 11) Subject to the fulfilment of the conditions under Sections 147/148, the Supreme Court expressly saved the Revenue Department’s power to re-open assessments. The need to save the powers under Section 147/148 was not necessary and provide a ‘remedy’ to the Revenue seems like a balancing act on the part of the Supreme Court. And not the least, the concept of not providing a remedy to Revenue when its interpretation of the impugned provision was not upheld has no jurisprudential basis.   

Anyhow the implications of the Supreme Court’s these observations are unclear, the Revenue Department filed a Miscellaneous Application, which inter alia sough clarification of the Supreme Court’s judgment vis-à-vis Section 150, IT Act, 1961 which deals with limitation period for assessments/reassessments. At the time of writing, the Supreme Court has directed the Revenue Department to file a review petition. The review will lead to another set of arguments because of the Supreme Court’s unnecessary ‘remedy’. 

[1] Principal CIT v Abhisar Buildwell P. Ltd 2023 SCC OnLine SC 481. 

[2] CIT, Central-III v Kabul Chawla (2015) 61 taxmann.com 412 (Delhi).  

One-Year Retrospect on Union of India v Mohit Minerals – II

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This is the second of a two-part post on the Supreme Court’s judgment in Union of India v Mohit Minerals[1] pronounced on 19 May 2022. In the first part, I focused on the Supreme Court’s observations on legal value of the GST Council’s recommendations. In this post, I will focus on the statutory aspects of the case: the arguments, the Supreme Court’s engagement with the same and the basis of its conclusion that IGST on ocean freight was not permissible. 

To briefly recall, the dispute centred around two Notifications issued by the Union. Notification 8/2017 provided IGST shall be levied on supply of services, i.e., transportation of goods in a vessel from a place outside India up to the customs clearance in India under a CIF contract. And an IGST of 5% was levied supply of such services. Notification 10/2017, issued under Section 5(3) categorised the recipient of such services to include the importer based in India with IGST payable under reverse charge.

Statutory Provisions and Relevant Arguments

At the outset, it is worth citing is Section 5(1) of IGST Act, 2017 which states that: 

Subject to the provisions of sub-section (2), there shall be levied a tax called the integrated goods and services tax on all inter-State supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 of Central Goods and Services Act and at such rates, not exceeding forty per cent., as may be notified by the Government on the recommendations of the Council and collected in such manner as may be prescribed and shall be paid by the taxable person: 

And, Section 5(3), IGST Act, 2017 which states that: 

The Government may, on the recommendations of the Council, by notification, specify categories of supply of goods or services or both, the tax on which shall be paid on reverse charge basis by the recipient of such goods or services or both and all the provisions of this Act shall apply to such recipient as if he is the person liable for paying the tax in relation to the supply of such goods or services or both.   

The assessee argued that Section 5(3) only delegates the power to identify the categories of goods or services on which tax shall be paid on reverse charge basis and not identify a recipient of supply. Notification 10/2017, on the other hand, identified the importer as a recipient for purposes of Section 5(3) and was ultra vires the IGST Act on the ground of excessive delegation. The Supreme Court rejected this argument and stated that the essential legislative functions had been performed by the legislature. It referred to Section 5(1), IGST Act, 2017 and Section 2(107), CGST Act, 2017 to conclude that levy of tax, subject matter of tax, value for purpose of taxation and taxable person had been provided in these respective provisions. Crucially, it referred to the definition of ‘recipient’ under Section 2(93) of CGST Act, 2017 which includes a person to whom possession or use of goods is made available. The importer of goods was included in this category. 

The Supreme Court concluded that the Union had in exercise of powers under Section 5(3) only specified the categories of supply and the stipulation that the importer was the recipient of supply of transportation services was only clarificatory. In other words, the Notification did not traverse beyond the statute in identifying the recipient and could not be said to suffer from the vice of excessive delegation. 

Regarding Section 5(1), IGST Act, 2017, the assessee argued that it is a charging provision and Sections 5(3) and Section 5(4) cannot be used to create an independent charge. The Supreme Court opined that Section 5(1) identifies the four canons of taxation: taxable event, taxable person, taxable rate, and taxable value. And that Section 5(3) and 5(4) are inextricably linked to the charging provision Section 5(1) as the charging and machinery provisions need to be understood as an integrated code. The Court then referred to Rule 31, CGST Rules, 2017 under which value of supply can be determined for cases not specifically mentioned in other rules, and concluded that neither of the two Notifications could be struck down on the ground of excessive delegation as they had correctly identified the taxable person and prescribed the IGST rate. The Supreme Court upheld the power to determine the tax rate through a Notification since the basic framework had been provided by the Parliament under the aforementioned provisions.  

The Supreme Court’s engagement with assessee’s argument on Section 5(1) is confusing. It engages with the assessee’s argument about excessive delegation, inter-relationship of the various sub-sections of section 5, IGST Act, 2017 in an overlapping manner without sufficiently clarifying either aspect. The relevant paragraphs of the judgment have an awkward logical flow and the reasoning on this point is uneven. And while the conclusion on the above mentioned points are correct, the reasoning lacks pinpointed analysis and is impeded by reference to numerous statutory provisions that are not relevant to the issues.   

Another crucial question that the Supreme Court had to engage with was: if imported goods on a CIF basis constituted an inter-State supply? The Supreme Court referred to Section 7, CGST Act, 2017 which inter alia defines supply to include ‘import of services for a consideration whether or not in the course or furtherance of business;’. It also referred to Section 7(4), IGST Act, 2017 which defines an inter-State supply to include supply of services imported into the territory of India. Referring to the above provisions, the Supreme Court noted that an Indian importer could be considered as importer of service of shipping liable to IGST if the activity falls within the definition of ‘import of service’. Accordingly, it then examined the definition of import of service.  

Section 2(11), CGST Act, 2017 states that import of services means the supply of any service, where – 

  • The supplier is located outside India; 
  • The recipient of service is located in India; and 
  • The place of supply of service is in India;

The assessee’s argument was that conditions (ii) and (iii) were not satisfied in the impugned case. The assessee was relying on the contract between the foreign exporter and the foreign shipping service based outside India. But the Supreme Court stated that the answer must be found in statutory provisions and not in terms of the contract. In pursuance of the same, it referred to Section 13(9), IGST Act, 2017 which provides that place of supply of services where location of supplier or location of recipient is outside India shall in case of service of transportation of goods shall be place of destination of such goods. Relying on Section 13(9), IGST Act, 2017 the Supreme Court held that since the goods under the CIF contract would enter the Indian taxable territory, place of supply of shipping service would be India. Thus, condition (iii) was held to be fulfilled in the impugned case. 

The thorny question was proving that the recipient of service was located in India to fulfil condition (ii). This could only be true if the importer was identified as the recipient of shipping services. The Supreme Court did not accept the State’s argument it had powers to designate any person to pay tax on a reverse charge basis irrespective of their status as a recipient. Neither did it accept that any person identified for payment of reverse charge would automatically become the recipient. On both counts the Supreme Court was right. However, the Supreme Court still concluded that the importer was a recipient by relying on the definition of recipient under Section 2(93)(c), CGST Act, 2017 which inter alia stated that ‘any reference to a person to whom a supply is made shall be construed as reference to the recipient of the supply’. Reading Section 2(93)(c), CGST Act, 2017 with Section 13(9), IGST Act, 2017 stated above, it concluded that: 

            In such a scenario, when the place of supply of services is deemed to be the destination of goods under Section 13(9) of the IGST Act, the supply of services would necessarily be “made” to the Indian importer, who would then be considered as a “recipient” under the definition of Section 2(93)(c) of the CGST Act. The supply can thus be construed as being “made” to the Indian importer who becomes the recipient under Section 2(93)(c) of the CGST Act. (para 118) 

By interpreting the definition of recipient in conjunction with place of supply, the Supreme Court relied on a deeming fiction to remove a major obstacle in the State’s way. In contractual terms, the recipient in a CIF basis would ordinarily be the exporter since the consideration flows from the exporter to the shipping company. But, the Supreme Court’s insistence on understanding the terms by referring to the statutory provisions instead of relying on commercial parlance proved fruitful for the State. (para 102) The Supreme Court’s approach also negatived the assessee’s challenge that levy was extra-territorial in nature since the transaction took place outside India. This is because as per the Supreme Court the destination of goods was India and services were ‘rendered for the benefit of the Indian importer.’ (para 108) Though the Supreme Court did not address the issues of extra-territoriality and identification of recipient in the same chronological fashion.   

IGST on Ocean Freight Runs into the Hurdle of Double Taxation

The State’s case fell on the benign hurdle of double taxation. It is important to first state that a composite supply means a supply made by a taxable person to a recipient consisting of two or more taxable supplies of goods or services or both which are naturally bundled together and supplied in conjunction with each other in the ordinary course of business. Section 8, CGST Act, 2017 states that a composite supply comprising of two or more supplies one of which is a principal supply, shall be treated as supply of such principal supply. The deeming fiction under Section 8 of CGST Act, 2017 being that two supplies would be treated as a single supply and would be subject to the tax rate of the principal supply.  

In the impugned case, for the first leg of the transaction between the foreign exporter and Indian importer, latter was liable to pay IGST on value goods, but the valuation included the cost of shipping services, i.e., cost of insurance and freight as the said transaction was treated as a composite supply. Thus, IGST was levied on supply of goods, since it was the principal supply in accordance with Section 8, CGST Act, 2017.  

The State argued that the second leg of the transaction between the foreign exporter and the shipping line should be treated as an independent contract operating in silos. The Supreme Court did not accept this argument reasoning that the State had argued that both legs of the transaction are connected when it argued that the importer was the recipient, but to tide over the composite supply provisions it is making a contradictory argument that the transactions are standalone. The State justified its contradictory stance by relying on the aspect theory wherein different aspects of a transaction can be subjected to different taxes. For instance, in the impugned case, the State could levy GST on the supply of imported goods as well as supply of transportation services, since they were different aspects of the same transaction.  

While the Supreme Court accepted that different aspects of a transaction can be taxed under the aspect theory, but it emphasised that in such a case value of goods cannot be included in services and vice-versa. While the State in the impugned case had included the value of services when levying IGST on supply of goods by invoking the concept of composite supply. The Supreme Court rightly concluded that supply of service of transportation by the foreign shipper forms a part of the bundle of supplies between the foreign exporter and Indian importer on which IGST is payable. To levy IGST on supply of service component of the transaction would contradict the principle under Section 8, CGST Act, 2017 and be in violation of the scheme of the GST legislation.     

Conclusion 

The Supreme Court in the impugned decision waxes eloquent on the nature and structure of GST and various parts of the judgment are informative and well-reasoned. At the same time, various provisions of CGST Act, 2017 and IGST Act, 2017 are cited that are not germane to the issue. The judgment though well-structured on first glance, struggles in identifying priority issues and its various parts seem superfluous and not necessary to adjudicate the central issue. While these might sound like lesser evils given some other judgments of the Supreme Court that lack basic reasoning, they are still worth mentioning. Overall, the judgment did arrive at the right conclusion, and endorsed a well-reasoned judgment of the Gujarat High Court which was under appeal in this case. Despite the State losing this case, there are several takeaways for it, one prominent one is that the net of extra-territorial taxation has been cast wide and beyond with the Supreme Court’s observations. If an Indian resident is the ultimate recipient of a transaction occurring outside India, the State can extend its GST jurisdiction on such an overseas transaction in various circumstances. It would be surprising if the Supreme Court’s views on nexus and extra-territoriality are not used in the future especially for further extending GST on online transactions that have a cross-border element.   

[1] Union of India v Mohit Minerals Pvt Ltd 2022 SCC OnLine SC 657.

One-Year Retrospect on Union of India v Mohit Minerals – I

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This is first of a two-part post that explores in detail the Supreme Court’s judgment in Union of India v Mohit Minerals[1]pronounced on 19 May 2022. In this crucial decision the Supreme Court ruled on the Union of India’s (‘Union’) competence to levy GST on ocean  freight and also examined legal value of the GST Council’s recommendations. The Supreme Court’s observations that the GST Council’s recommendations are not binding garnered attention of most commentators who made doomsday predictions about GST. I’m using the one-year ‘anniversary’ of the decision as an opportunity to examine the decision in detail and hopefully clarify some misgivings about the Supreme Court’s observations.  

First of this two-part post will focus on the Supreme Court’s opinion on nature of recommendations of the GST Council and the second part will focus on the reasoning deployed by the Supreme Court to conclude that GST on ocean freight is unsustainable.  

Introduction

The dispute centred around two Notifications issued by the Union which levied IGST on supply of services, i.e., transportation of goods in a vessel from a place outside India up to the customs clearance in India under a CIF contract. And categorised the importer based in India as the recipient of such services with IGST payable under reverse charge. The relevant provisions – for the purposes of this post – are Sections 5, 6, and 22 of the IGST Act, 2017. Section 5 states that the Government may ‘on the recommendations of the Council’ specify the IGST rates on inter-State supplies of goods or services or both. Section 6 empowers the Government to exempt, absolutely or conditionally, goods or services ‘on the recommendations of the Council’. And Section 22 states the Government may ‘on the recommendations of the Council’ make rules for carrying out the provisions of this Act. 

The Union argued that the recommendations of the GST Council – made to the Union and States under Article 279A(4) of the Constitution – are binding and its rule making exercisable on such recommendations are very wide. To engage with the Union’s argument, the Supreme Court had to examine the effect of the 101st Constitutional Amendment, 2016 which inter alia introduced two new provisions to the Constitution, i.e., Article 246A – which confers legislative powers with respect to GST on the Union and States – and Article 279A, which envisages the GST Council and prescribes the nature and scope of its work.    

Using Legislative History as an Aid to Constitutional Interpretation

The Supreme Court examinedlegislative history of the 101st Constitutional Amendment and arrived at two major findings with regard to Article 246A: first, that Article 246A departs from the previous Constitutional scheme of complete separation of taxation powers between the Union and States characterised by absence of any major taxation entry in the Concurrent List; second, Article 246A is not subject to a repugnancy provision unlike Article 246(2) which is subject to Article 254. Based on the above, it concluded that:

The concurrent power exercised by the legislatures under Article 246A is termed as a ‘simultaneous power’ to differentiate it from the constitutional design on exercise of concurrent power under Article 246, the latter being subject to the repugnancy clause under Article 254. The constitutional role and functions of the GST Council must be understood in the context of the simultaneous legislative power conferred on Parliament and the State legislatures. It is from that perspective that the role of the GST Council becomes relevant. (para 30)

The Supreme Court’s observations on Article 246A underscored that the Union and States were on an equal footing under Article 246A, and neither could claim primacy over the other in exercising legislative powers under the said provision. 

In understanding role of the GST Council, the Supreme Court again relied on legislative history and emphasised that the draft version of Article 279A – in the Constitution Amendment Bill, 2011 – provided that the GST Council would only make recommendations through a unanimous decision and a dispute settlement authority would adjudicate on disputes that may arise if there are deviations from its recommendations. Both aspects were later amended: first, Article 279A(9) of the Constitution provides that the GST Council can make recommendations with a majority of votes; second, Article 279A(11) provides the GST Council is empowered to establish a mechanism to adjudicate any dispute arising out of its recommendations instead of envisaging a permanent dispute settlement authority. 

The Supreme Court reasoned as to why the changes were made. First, by allowing the GST Council to make recommendations via majority decisions was, as per the Supreme Court, a nod to the spirit of federalism. It was acknowledgment of the fact that not all decisions could be reached through unanimity and consensus. Second, the Supreme Court referred to Parliamentary debates and views of the Standing Committee on Finance to observe that the States were concerned about their autonomy if a permanent dispute settlement authority would have jurisdiction over their decisions and to examine if they deviated from the recommendations of the GST Council. Accordingly, Article 279A empowers the GST Council regarding modalities of dispute resolution and does not envisage a permanent dispute resolution body. 

Relying on the legislative history and its reasoning that the GST Council is meant to be a body to facilitate dialogue in the co-operative federal setup of India, the Supreme Court concluded that the notion that the recommendations of the GST Council transform into legislation in and of themselves under Article 246A is far-fetched. More crucially, the Supreme Court observed that the Parliamentary debates indicate that recommendations of the GST Council were only meant to assist the Union and States in their legislative functions and not overpower them. The Supreme Court reasoned that neither does Article 279A begin with a non-obstante clause nor does Article 246A provide that it is subject to Article 279A. Further, the Supreme Court observed, that if the recommendations of the GST Council were to transform into legislation without an intervening act, there would have been an express provision to that effect in Article 246A. 

Bifurcating Recommendations into Two Categories 

The Supreme Court rejected the Union’s argument that the recommendations of the GST Council are binding. Relying on legislative intent, its interpretation of Article 246A and Article 279A, and character of Indian federalism, the Supreme Court concluded that: 

            .. the Centre has a one-third vote share in the GST Council. This coupled with the absence of the repugnancy provision in Article 246A indicates that recommendations of the GST Council cannot be binding. Such an interpretation would be contrary to the objective of introducing the GST regime and would also dislodge the fine balance on which Indian federalism rests. Therefore, the argument that if the recommendations of the GST Council are not binding, then the entire structure of GST would crumble does not hold water. (para 51)

The above observations logically flow from the Supreme Court’s view that Article 246A provides simultaneous legislative powers to the Union and States but, in the GST Council, the Union possesses greater voting weightage. Thus, the recommendations of the GST Council under Article 279A cannot be binding as it would dilute the powers granted to the States under Article 246A.

The above cited paragraph also captures the two factors that the Supreme Court had to weigh in deciding the legal value of the recommendations of the GST Council: uniformity of GST regime vis-a-vis State autonomy. If the recommendations of the GST Council under Article 279A were to be held to be binding, it would have ensured complete uniformity of GST but further sacrificed the already diminished State autonomy. More pertinently, it would have diluted the true scope of Article 246A. The Supreme Court correctly weaved the inter-relationship of Article 246A with Article 279A, and stitched it together with its views on the GST Council as a body to facilitate dialogue and act as a platform to further co-operative federalism.       

However, the Supreme Court added that not all recommendations of the GST Council are non-binding. The Supreme Court went ahead to state that the GST Council’s recommendations are binding on the Government when it exercises its power to notify secondary legislation to give effect to the uniform taxation system. (para 59) This conclusion rests on thin ice. There are two proximate reasons for the Supreme Court’s aforementioned conclusion: first, that the secondary legislation framed based on recommendations of the GST Council has to be mandatorily tabled before the Houses of the Parliament; second, it is important to give effect to a uniform taxation system since GST was introduced to prevent different States from providing different tax slabs and exemptions. (paras 56 and 59)

Section 164, CGST Act, 2017 and Section 22, IGST Act, 2017 empower the Government to make rules, on the recommendation of the Council, to carry out the provisions of the respective legislations. Every rule, regulation and notification is to be laid before each House of the Parliament. More importantly, Section 166, CGST Act, 2017 and Section 24, IGST Act, 2017 empower both Houses to modify any rule or regulation or notification, or prevent them from having effect. In holding that the Government is bound to notify secondary legislation to give effect to uniform tax rates under GST, the Supreme Court ignored Section 166 of CGST Act, 2017 and Section 24 of IGST Act, 2017. Is the power provided to both the Houses to prevent issuance of certain Notifications redundant in so far as Notifications relating to GST rates are concerned? The Supreme Court gave no credible explanation as to why cannot the spirit of co-operative federalism that is supposed to guide all other decisions in the GST Council be invoked for uniform tax rates as well? While uniformity in GST is its stated and desirable goal, but it cannot be achieved through a route that bypasses statutory provisions.     

I would also like to highlight that, in its rather detailed analysis of Article 279A, the Supreme Court completely bypassed the fact that the GST Council members, in various instances, effectively make recommendations to themselves. The Union Finance Minister as the ex-officio Chairperson of the GST Council and State Finance Ministers as the members, are the Ministers responsible for implementation of GST. Any recommendations of the GST Council that require executive action are to be acted upon by its Chairperson and its members in their capacities as the respective Finance Ministers. This ensures that the recommendations, except when they require legislative approval, are on a de facto basis binding. Thus, when the Supreme Court observed that certain recommendations of the GST Council – requiring notification of tax rates – are binding, it unhesitatingly approved the revolving door mechanism of the GST Council, and gave de jure status to an inherently flawed mechanism. While the fault lies in the Constitutional mechanism encoded in Article 279A, it was necessary in this detailed judgment to examine this aspect of Article 279A and duly account for it before adjudicating on the legal value of the recommendations of the GST Council.   

While bifurcating the GST Council’s recommendations into two categories is not incorrect per se, the Supreme Court’s conclusion about the binding nature of recommendations that relate to tax rates is devoid of persuasive reasoning. In my view, it muddles the Supreme Court’s own views about the role of GST Council and introduces unnecessary complexity in interpreting Article 279A and does not meaningfully examine crucial statutory provisions that provide important powers to the Houses to scrutinise secondary legislation.            

Conclusion

Apart from its conclusion that the GST Council’s recommendations are binding on the Government when its notifies tax rates and its omission on factor the revolving door mechanism, the Supreme Court judgment provides elaborate reasons. The observations of the Supreme Court, however, caused consternation because of its perceived implications. The truth is that the ‘Grand Bargain’ of GST is based on an agreement between the Union and States and the GST Council merely acts as a facilitative body to realise the said promise.  The effect of the 101st Constitutional Amendment is that the States pool their sovereignty with the Union, but are not legally bound to toe the line of the Union or the GST Council on every aspect of GST. And the Supreme Court’s decision makes amply clear an obvious Constitutional position reflected in Article 246A and Article 279A. However, the Supreme Court’s observations do not imply that GST is under ‘threat’ or has received a ‘fatal blow’. Administration of GST has the Union and States increasingly inter-twined, and for a State or some States to attempt their own GST regime would require a gigantic effort. And an equally compelling reason. 

At the same time, the Supreme Court’s observations clarify that States have enough elbow room, legally speaking, to pushback against an overbearing Union and  ensure that decision making on GST remains undergirded by dialogue, consensus and co-operation. The inter-dependence of the Union and States is not a utopian ideal – and the Supreme Court does paint a rosy picture of co-operative Indian federalism in its judgment – but, a practical need for both sides. 

[1] Union of India v Mohit Minerals Pvt Ltd 2022 SCC OnLine SC 657. 

Machinery Provisions Brook No Vested Rights: Supreme Court Holds that Amendment to Section 153C, IT Act, 1961 is Retrospective

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On 6 April 2023, a Division Bench of the Supreme Court in Vikram Bhatia case[1], held that the amendment to Section 153C, IT Act, 1961 was retrospective in nature and would be applicable to searches conducted even before the date of amendment, i.e., 1.06.2015. The Supreme Court’s decision is another example of its deferential approach to the State in tax matters. The impugned case also highlights that the Revenue Department is not hesitant to argue that an amendment is retrospective on the pretext that the pre-amendment provision was interpreted contrary to legislative intent. An argument that the Supreme Court and other Courts have not scrutinized with necessary rigor.  

Background to Amendment of Section 153C, IT Act, 1961 

The relevant portion of Section 153C, as it stood before its amendment vide the Finance Act, 2015, provided that where the assessing officer is satisfied that any money, bullion, jewellery or other valuable article or thing or books of account or documents seized or requisitioned belongs or belong to a person other a person against whom search is conducted, then such books of account or assets shall be handed over to the assessing officer having jurisdiction over the other person. And the other person may be issued notice and their income reassessed under Section 153-A, IT Act, 1961.   

The Delhi High Court in Pepsico India case[2] held that the words ‘belongs or belong to’ should not be confused with ‘relates to or refers to’. In this case, the Delhi High Court noted that if  the purchaser’s premises are searched and a registered sale deed is seized, it cannot be said that it ‘belongs to’ to the vendor just because his name is mentioned in the document. (para 16) The Delhi High Court’s interpretation meant that the assessing officer could only initiate proceedings against a third party if the incriminating material found during search proceedings ‘belonged to’ the third party and not merely ‘related to’ the third party. The Revenue Department’s stance was that the Delhi High Court’s interpretation did not align with the intent of the provision. Though the Revenue Department’s disagreement with the Delhi High Court’s ruling could also stem from the fact that its interpretation set a high threshold for the assessing officer to invoke Section 153C against a third party. 

To overcome the effect of the Delhi High Court’s judgment, Finance Act, 2015 amended Section 153C, and Section 153C(1)(b) now states that where the assessing officer is satisfied that any books of account or documents, seized or requisitioned, pertains or pertain to, or any information contained therein, relates to, person other than against whom search is conducted, then such books of account or assets shall be handed over to the assessing officer having jurisdiction having jurisdiction over the other person. And the other person may be issued notice and their income reassessed under Section 153-A, IT Act, 1961.   

The scope of Section 153C was clearly widened, the threshold to proceed against a third party was lowered with the phrase ‘belongs to’ being replaced with ‘relates to’. The expression ‘belongs to’ though continued to qualify money, bullion, jewellery or other valuable article or thing mentioned in Section 153C(1)(a).  

Interpretation of Amended Section 153C, IT Act, 1961      

The Supreme Court heard appeals from common judgment[3] of the Gujarat High Court pronounced in April 2019. The Gujarat High Court observed that though Section 153C was a machinery provision, but by virtue of its amendment new class of assessees were brought within the scope of the provision and it affected their substantive rights and resultantly Section 153C could not be interpreted to be a mere procedural/machinery provision. Further, the Gujarat High Court reasoned that the amended provision was much wider in scope as compared to its predecessor. The Gujarat High Court concluded that amendment to Section 153C shall not be given a retrospective effect, and no notices could be issued post-amendment of Section 153C for searches conducted before its amendment, i.e., 1.06.2015. Against this decision of the Gujarat High Court, the Supreme Court heard appeals filed by the Revenue Department.    

The precise question before the Supreme Court was whether amendment to Section 153C, IT Act, 1961 was retrospective? And whether Section 153C, IT Act, 1961 would be applicable to searches conducted before 1.06.2015, i.e., the date before amendment. The Supreme Court answered in the affirmative. There are several limitations in the Supreme Court’s approach, let me highlight a few below. 

First, the Supreme Court accepted the State’s argument that the amendment to Section 153C, IT Act, 1961 was ‘a case of substitution of the words by way of amendment’. (para 10.1) The Supreme Court cited numerous precedents to the effect without really explaining the basis on which it was deciphering that the amendment in question was a ‘substitution’ amendment. In fact, the Supreme Court adopted a broad brush approach and neglected to observe that even post-amendment Section 153C(1)(a) retains the phrase ‘belongs to’. Section 153C(1), after amendment vide the Finance Act, 2015 states that: 

Nothwithstanding anything contained in section 139, section 147, section 148, section 149, section 151 and section 153, where the Assessing Office is satisfied that,-

  • any money, bullion, jewellery or other valuable article or thing, seized or requistioned, belongs to; or 
  • any books of account or documents, seized or requistioned, pertains or pertain to, or any information contained therein, relates to,   

a person other than the person referred to in section 153A, … (emphasis added) 

Clearly, both phrases ‘belong to’ and ‘relates to’ have been retained in Section 153C. And the afore cited portion of Section 153C provides reasonable basis to argue that the Finance Act, 2015 did not effectuate a ‘substitution amendment’ of Section 153C. The amendment only lowers the threshold to initiate the proceedings against the third person for certain kinds of documents and does not fully substitute the pre-amended provision.    

Second, the Supreme Court reasoned that Section 153C, IT Act, 1961 was a machinery provision and it must be construed to give effect to the purpose and object of the statute. (para 10.6) The Supreme Court then cited a host of decisions to support its stance that machinery provisions must be construed liberally. However, the decisions cited by the Supreme Court such as Calcutta Knitwears case[4], hold that machinery provisions should be interpreted liberally to give meaning to the charging provision. The judicial precedents on this issue do not state that machinery provisions should be interpreted liberally per se. Neither do any of the precedents cited by the Supreme Court state that legislative intent needs to be placed at the highest pedestal without weighing it against other factors such as taxpayer rights. 

Third, the Supreme Court rejected the assessee’s contention that Section 153C, IT Act, 1961 should not be interpreted to have retrospective effect since it affected the substantive rights of the third party. The Supreme Court rejected the argument on the ground that the pre-amended Section 153C was also applicable to the third party. While the Supreme Court is right, its statement does not sufficiently appreciate that the threshold to proceed against the third party after amendment to Section 153C was lowered directly affecting the rights of such party. Instead, it stressed that there was legislative intent to proceed against the third party before and after the amendment without delving into the details. Equally, the Supreme Court dismissed the argument that there is presumption against retrospectivity of a statute. The Supreme Court examined the jurisprudence on presumption against/for retrospectivity superficially. At no place in the judgment is there an examination as to why and how the amendment to Section 153C is ‘declaratory’ and why presumption against its retrospectivity is inapplicable.            

Fourth, which overlays with the second point, is that the Supreme Court laid considerable emphasis on legislative intent. Despite immense emphasis on legislative intent, the Supreme Court did not examine as to why one sub-clause of Section 153C continued to retain ‘belongs to’ after the amendment. And, neither did it refer to any source that helps us understand the original legislative intent or the intent behind amendment to Section 153C. In the absence of such references, legislative intent is a malleable phrase in the hands of any adjudicating authority, and it was used as such in the impugned case.  

Fifth, the Supreme Court stated that the Delhi High Court construed the term ‘belongs’ unduly narrowly and restrictively, but never clarified the precise objection to the High Court’s interpretive approach. Strict interpretation of tax statutes is the default approach of Courts, and deviations from it need to be justified not adherence to it. The Delhi High Court was clear in its judgment that a tax statute must be interpreted strictly and in case of doubt or dispute must be interpreted in favor of the assessee. (para 7) And the Delhi High Court adopted such an approach in construing Section 153C, IT Act, 1961. The Supreme Court never truly explained how adopting such an approach by the Delhi High was an unjust or restrictive interpretation. 

Sixth, the Supreme Court took made an interesting point when it referred to First Proviso to Section 153C. The said Proviso contains a deeming fiction where in case of a third person, the reference to the date of initiation of the search under Section 132 shall be construed as reference to the date of receiving of books of account or documents or assets seized or requisitioned by the assessing officer having jurisdiction over such person. The deeming fiction in the First Proviso moves the date of initiation of search to the date the assessing officer of the third person receives the documents. In the impugned case, while the search took place before 1.06.2015, the assessing officer of the third party received the documents on 25.04.2017 and issued notice to the third party on 04.05.2018. Thus, as per the deeming fiction, the search against the third party was initiated after 1.06.2015. Given these set of facts, it was not unreasonable to suggest that the applicable provision should have been the amended Section 153C. The Supreme Court’s used the First Proviso to support its conclusion (para 10.3) But the Supreme Court did not delve into the implication of the First Proviso adequately vis-à-vis its repeated emphasis on legislative intent. The Supreme Court observed that not allowing the Revenue Department to proceed against the third party ‘solely on the ground that the search was conducted prior to the amendment’ would frustrate the object and purpose of the amendment. In arriving at this conclusion, the Supreme Court did not satisfactorily examine how the deeming fiction in the First Proviso to Section 153C makes the actual date of initiation of search irrelevant for the third person.   

Conclusion 

The Supreme Court granting the State leeway in tax (and economic) laws is a well-entrenched doctrine in Indian tax jurisprudence. In this case, the Supreme Court used the doctrine impliedly to stamp its approval to an amendment to IT Act, 1961, stating that the amendment was retrospective in effect, without articulating its reasoning in a cogent and defensible manner. While the deeming fiction in the First Proviso to Section 153C lends some support to the Supreme Court’s conclusion, there was need for more robust reasoning to interpret the amendment to be retrospective in nature. The amendment of Section 153C has an appreciable impact on the substantive rights of the third parties. This factor alone was sufficient for the Supreme Court’s conclusion to be based on impeccable reasoning, but we only saw a glimpse of it in the judgment. 

[1] Income Tax Officer v Vikram Sujit Kumar Bhatia 2023 SCC OnLine SC 370. 

[2] Pepsico India Holdings Private Limited v ACIT 2014 SCC OnLine Del 4155. 

[3] Supreme Court, in its judgment, did not specifically state the name of parties and the exact decision. Though one of the Gujarat High Court’s decision decided in 2019 is Anikumar Gopikishan Aggarwal v CIT [2019] 106 taxmann.com 137 (Guj). In this case, the Gujarat High Court decided that amendment to Section 153C, IT Act, 1961 was prospective in nature.  

[4] Commissioner of Income Tax, III v Calcutta Knitwears, Ludhiana (2014) 6 SCC 444. 

Supreme Court Opines on Residence Rule under IT Act, 1961: Traverses Familiar Path

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In a judgment[1] delivered on 10 April 2023, a Division Bench of the Supreme Court opined on the residency principle of companies under Section 6(3)(ii) of IT Act, 1961. While there were a few other issues involved in the case, in this post I will focus on Supreme Court’s treatment of the residency principle of companies and how it missed an opportunity to advance the jurisprudence on this issue. Instead, it merely reproduced the ratio of previous judgments without adding any substantive value. 

Before proceeding, it is important to state that Section 6(3)(ii), IT Act, 1961 was amended in 2017. Pre-amendment, Section 6(3)(ii) stated that a company is said to be resident in India if the control and management of its affairs is situated wholly in India. Post-2017, Section 6(3)(ii) states that a company is said to be resident in India in any previous year if its place of effective management, in that year, is in India. The pre-amendment clause was applicable in the impugned case. The State though argued that to cull the meaning of pre-2017 clause it is important to consider the post-2017 clause, but this argument wasn’t expressly endorsed by the Supreme Court. (para 4.5) 

Facts and Issues 

Assessees in the impugned case were companies registered in Sikkim under the Registration of Companies (Sikkim) Act, 1961. Their business was to act as commercial agents for sale of cardamom and other agricultural products. The case of assessees was that they were residents of Sikkim and conducted their business in Sikkim and were thus governed by Sikkim State Income Tax Manual, 1948 and not IT Act, 1961. The reason the two income tax statutes were in question was because of historical reasons. Sikkim became part of India in April 1975, but all Indian laws were not immediately made applicable to Sikkim. Thus, residents of Sikkim continued to be governed by the Sikkim State Income Tax Manual, 1948. This was until Finance Act, 1989 proposed to make IT Act, 1961 applicable to Sikkim commencing from 1 April 1990. Thus, for the period prior to 1 April 1990, the assessees were foreign companies under IT Act, 1961 and could be considered as Indian residents only if control and management of their affairs was situated wholly in India. The State’s entire case was that the companies satisfied the latter criteria under Section 6(3)(ii), IT Act, 1961.   

The State contended that the assessees were not residents of Sikkim based on the documents obtained from their Delhi-based accountants in a search operation. The accountants were found in possession of book of accounts, signed blank cheques, cheque books, letter heads, rubber seals, and other income documents of the assessees. The State further alleged that the accountants were appointing Directors of the companies and thus the control and management of the assessees was completely from Delhi. 

The issue before the Supreme Court – and one that I focus on in this post – was: should the assessees be considered as residents of Sikkim due to reason of their incorporation in Sikkim or should they be considered as residents of India since they were (allegedly) completely managed and controlled from Delhi?   

Summary of Jurisprudence 

The Supreme Court dutifully cited the precedents that have elaborated on the test to determine the residence of a company not incorporated in India or to determine the control and management of HUF. The leading case on the issue is that of VVRNM Subbaya Chettiar[2], where in determining the residence of HUF under the Income Tax Act, 1922 the Supreme Court opined that ‘control and management’ signifies that the controlling and directive power or the ‘head and brain’ is functioning at a particular place with a certain degree of permanence. And since control and management of a company remains in the hand of a person or group of persons the question to be asked is wherefrom such person or group of persons control the company. Mere activity of a company at a particular place did not create its residence at that place. This test, in short referred to as the ‘substance over form’ test has been endorsed in subsequent decisions as well. For example, in Erin Estate[3] case the Supreme Court observed that the test was a mixed question of law and fact and clarified that what was necessary to show was from where the de facto control and management was exercised in the management of the firm and not the place from where the theoretical or de jure control was exercised. Similarly, in Narottam and Pereira Ltd[4]  the Bombay High Court observed that the authority which controls and manages the employees and servants is the central authority, and the place from where such central authority functions is the residence of the company.     

Expressing its agreement with the above line of jurisprudence, the Supreme Court stated that in the impugned case the Assessing Officer and Commissioner of Income Tax (Appeals) rightly concluded that the control and management of the assessees was with their accountants in Delhi and thus residence was in India. And that the conclusion is aligned with the findings of fact and material on record.  

No Substantial Addition to the Jurisprudence  

Given the set of facts detailed in the judgment, the Supreme Court’s decision seems justifiable. However, it also feels like a missed opportunity as the Supreme Court never really went beyond what was stated in the precedents. The facts offered an opportunity to examine – in some depth – how and if certain situations prove or lend support to the assertion that an assessee is controlled from a place other than its place of incorporation. Was the fact of an accountant possessing all relevant materials and documents of a company sufficient for an irrefutable conclusion that the accountant controlled the company? Or was the additional fact of an accountant appointing and controlling the Directors of a company an equal or more decisive factor? Further, inability to prove that assessees received all their payments in Sikkim and that their rates of commission were astronomical/unrealistic were relied on by the Supreme Court to arrive at its conclusion. But we are left unaware as to which fact was decisive or was it the combination of facts that tilted the case against the assessees. 

One crucial aspect that the Supreme Court did not address clearly was the burden of proof in such cases. It is important to note that the two cases that the Supreme Court cited approvingly, i.e., VVRANM Subbaya Chettiar and Erin Estate cases made their observations in the context of Section 4-A(b), IT Act, 1992 (the predecessor of Section 6(2), IT Act, 1961) where the burden of proof is on assessee to show that the HUF is not a resident of India. And in Erin Estate case it was clearly stated that the onus to rebut the initial presumption is on the assessee. (para 6) While under Section 6(3)(ii), IT Act, 1961, the applicable provision in the impugned case, the initial burden is on the State to show that a company incorporated outside India is wholly managed from India.    

In the impugned case, the petitioners argued that the State had not discharged its onus that the control and management of the company was wholly situated in India. (para 3.14) The Delhi High Court’s judgment which was under appeal had mentioned that once all the materials and documents of the company were discovered in possession of the accountants, the burden was on the assessee to prove that the residence of company was not in India. (para 6.3) Since the Supreme Court did not find any error in the Delhi High Court’s findings on this issue, it stands to reason that the High Court’s view was upheld. Is discovery of important documents of a company from a place other than the place of incorporation/registered office sufficient to shift the burden of proof to assessees? We do not have clear answers.    

The result is that the Supreme Court’s judgment apart from reiterating the substance over form test, added no significant jurisprudential value to the residence test under Section 6(3)(ii) of the IT Act, 1961.    

[1] Mansarovar Commercial Pvt Ltd v Commissioner of Income Tax, Delhi 2023 LiveLaw (SC) 291. 

[2] V.V.R.N.M. Subbayya v CIT, Madras AIR 1951 SC 101. 

[3] Erin Estate v CIT AIR 1958 SC 779. 

[4] Narottam and Pereira Ltd v CIT, Bombay City 1953 23 ITR 454 Bom. 

Onerous Burden: Supreme Court Restricts ITC Claims under KVAT Act, 2003

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A Division Bench of the Supreme Court on 13 March 2023, decided a group of appeals under the Karnataka Value Added Tax Act, 2003 (‘KVAT Act, 2003’) and denied Input Tax Credit (‘ITC’) to purchasers.[1] While the dispute was under KVAT Act, 2003, the interpretive approach adopted by the Supreme Court could have some repercussions for taxpayers under GST. The aim of this post is to understand the Supreme Court’s interpretive approach and examine its relevance to GST. 

Introduction

The Supreme Court decided a group of appeals involving purchasers who were claiming ITC under the KVAT Act, 2003. The State denied purchasers ITC on the ground the sellers fell in either one of the following categories: they had filed ‘Nil’ returns, or were de-registered, or did not file returns or denied their turnover and refused to file taxes. The Karnataka High Court allowed purchasers to claim ITC on the ground that they had made payments to the sellers through account payee cheques and had produced relevant invoices to prove genuineness of the sale transactions. (para 4.1) The State filed appeal against the High Court’s decision in the Supreme Court.  

Conditions to Claim ITC 

The central provision in the dispute was Section 70(1), KVAT Act, 2003 which provides that: 

For the purposes of payment or assessment of tax or any claim to input tax under this Act, the burden of proving that any transaction of a dealer is not liable to tax, or any claim to deduction of input tax is correct, shall lie on such dealer. 

The State argued that purchasers cannot claim to have successfully discharged the burden under Section 70, KVAT Act, 2003 by merely proving financial transfers/transactions through invoices and cheques. To discharge their burden, the State argued, the purchasers are also required to establish actual movement of goods. The State further argued that the High Court had not appreciated the fact that the State cannot recover taxes from a seller who files ‘Nil’ returns. The purchasers, on the other hand, argued that once they produce genuine invoices and evidence of payments through cheques, it should be considered sufficient discharge of their burden under Section 70, KVAT Act, 2003. And that the statute and the relevant Rules under KVAT Rules, 2005 – Rules 27 and 29 – did not require a purchaser to submit any additional documents to claim ITC. The purchasers further argued that if the seller had not paid the tax, then the State needs to recover the tax from the seller and not block their ITC. 

Interpreting Burden of Proof under Section 70 of KVAT Act, 2003  

The narrow issue that the Supreme Court was required to decide was if proving movement of goods was necessary for a purchaser to discharge the burden under Section 70, KVAT Act, 2003. The Supreme Court answered in the affirmative and held that proving genuineness of the transaction and physical movement of goods is sine qua non to claim ITC and the same can only be proved through name and address of the selling dealer, details of the vehicle, acknowledgement of the delivery of goods, etc. The Supreme Court held that:

If the purchasing dealer/s fails/fail to establish and prove the said important aspect of physical movement of the goods alleged to have been purchased by it/them from the concerned dealers and on which the ITC have been claimed, the Assessing Officer is absolutely justified in rejecting such ITC claim. (para 10)

Supreme Court repeated the same observation thrice in its judgment to emphasise that unless the purchaser proves movement of goods, the genuineness of the transaction could not be established and in its absence the burden of proof under Section 70, KVAT Act, 2003 was not discharged by the purchasers. In my view, the Supreme Court repeatedly states its conclusion in the judgment to disguise it as reasoning. There is no explanation by the Supreme Court as to why proving movement of goods should be read as an essential condition under Section 70, KVAT Act, 2003. If the relevant statutory provisions and Rules did not impose an express condition on the purchaser to prove movement of goods and the same was being read into the provisions, there was an additional need for the Supreme Court to provide its reasons. Merely repeating the same conclusions do not reinforce an interpretation or make it more defensible.  

In this case, the relevant provision(s) were silent if the purchaser needs to prove the movement of goods. The facts elaborated in the judgment do not clearly establish if interpreting the additional condition of movement of goods was necessary. The State argued that the additional condition was necessary to prove genuineness of the transaction and the Supreme Court certainly went beyond the text of the statutory provisions and relevant Rules to accept the State’s argument. Perhaps the Supreme Court in trying to prevent tax evasion and fraudulent ITC claims did not give sufficient thought about the need to protect taxpayer rights. Or maybe the Supreme Court was trying to compensate for an oversight in legislative drafting. Irrespective, the deficient reasoning is palpable in the judgment.        

Attributing Fault, Denying ITC, and Position under GST  

The Karnataka High Court by allowing ITC claims had agreed with the purchaser’s argument – also repeated before the Supreme Court – that they cannot be held liable for seller’s failure to deposit the tax. While the State argued that a purchaser can only claim ITC on the tax paid by the seller, and if the seller does not deposit tax, it is logical to block ITC of the purchaser. GST seeks to address the same issue, i.e., who should be liable for the seller’s failure to deposit tax with the State? Can the State block or reverse ITC of a purchaser because of the seller’s fault? If so, under what circumstances? We do not have clear answers for now.   

One of the conditions to claim ITC is provided under Section 16(2)(c), CGST Act, 2017 which states that no person shall be entitled to ITC in respect of supply of any goods or services or both unless the tax charged in respect of such supply ‘has actually been paid to the Government’ either through cash or utilization of ITC. Thus, seller must deposit the tax for a purchaser to successfully claim ITC. 

Further, after a series of amendments, it is not possible for a purchaser to claim ITC unless the seller has filed their GST returns indicating the supplies on which the purchaser can claim ITC.[2] Linking the ITC claims to seller’s returns certainly seems to make the co-operation of purchaser and seller necessary to claim ITC.  However, in my view, the statutory provisions do not decisively attribute liability in case of seller’s inability or failure to deposit the tax.  

In M/s D.Y. Beathel Enterprises[3], a case decided under Tamil Nadu Goods and Services Tax Act, 2017 (pari materia with CGST Act, 2017), the Madras High Court ‘did not appreciate’, the approach of the Revenue whereby they reversed ITC of the purchaser while not initiating any recovery action against the seller for not depositing the tax. The High Court observed that inquiry against the seller was necessary since the State made claim that there was no movement of goods. The High Court held that if the State does not receive the tax, liability has to be borne by one party – seller or buyer, but it did not specifically state which party must bear the burden. And it remanded the matter back to the Revenue Department directing initiation of fresh inquiry against both the purchaser and seller. 

The Madras High Court’s decision cannot be treated as precedent under GST for all kinds of fact situations and the final word on the issue is yet to be spoken. Also, the High Court did not conclusively attribute liability to one party but directed action against both – purchaser and seller. And if the Supreme Court’s interpretive approach under KVAT, 2003 is any indication, the purchasers are unlikely to find it easy to claim ITC under GST or are likely to get their ITC reversed if the seller defaults or delays filing of their returns or otherwise does not deposit tax with the State. If and when the liability will be attached to purchaser due to the conduct of the seller is currently an open question.        

[1] State of Karnataka v M/s Ecom Gill Coffee Trading Private Limited 2023 SCC OnLine SC 248. 

[2] Section 16(2) and Section 38 of CGST Act, 2017 were amended via the Finance Act, 2022 with the result that the purchasing dealer is dependent on the supplier furnishing its GSTR-1. 

[3] M/s D.Y. Beathel Enterprises v State Tax Officer 2021-VIL-308-MAD. 

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