Rav Singh

State’s Powers to Secure Loans: Kerala-Union Tussle 

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The State of Kerala (‘Kerala’) recently filed an original suit against the Union of India (‘Union’) alleging that the latter has interfered with its fiscal autonomy by imposing a ceiling limit on its borrowing powers. The issue has been brewing for a while and Kerala has only recently approached the Supreme Court, which is yet to adjudicate on this issue. Kerala’s suit though brings into focus an important but largely ignored provision of the Constitution, i.e., Article 293. This article is an attempt to understand the provision and the related legal issues in the dispute between Kerala and the Union. 

Kerala Alleges Violation of Fiscal Autonomy 

Relevant media reports reveal that Kerala has challenged the Union’s amendment to Section 4, Fiscal Responsibility and Budget Management Act, 2003 (‘FRBM’) introduced via Finance Act, 2018. The two relevant amendments made to FRBM in 2018 are: first, amendment of definition of the term ‘general Government debt’ which has been defined to include sum total of debt of Central and State Governments, excluding inter-Governmental liabilities; second, Section 4(1)(b) which inter alia states that the Central Government shall ‘endeavour’ to ensure that the general Government debt does not exceed 60% of GDP by end of the financial year 2024-25. Section 4(1)(b) also states that the Central Government shall endeavour to ensure that the Central Government debt does not exceed 40% of GDP by end of the financial year 2024-25. 

The implication of the above amendments is that State debt is included in the definition of ‘general Government debt’ in FRBM even though it is a central legislation. Also, the desirable upper limit of fiscal deficit of all States is 20% of the GDP. As a result of this amendment, State debt levels are not exclusively within their control under State-level FRBMs, but also under the Union-FRBM.  

Kerala has challenged the above amendment specifically the amended definition of ‘general Government debt’ whereby State debts have been included in the term. Kerala’s argument is that ‘public debt of the State’ is a matter exclusively within the State’s competence under Entry 43, List II of the Seventh Schedule. By introducing a ceiling limit on the State’s borrowing, the Union is infringing the State’s fiscal autonomy. Kerala is arguing that States have fiscal autonomy to borrow money on the security and guarantee of the Consolidated Fund of the State and have exclusive power to regulate their finances through preparation and management of its budget. Union’s interference in the borrowing powers of States is violation of the fiscal federal structure envisaged under the Constitution.   

Mandate of Article 293 

Kerala’s challenge also touches Article 293 of the Constitution. Kerala’s arguments, as reported, are that relying on the 2018 amendments to FRBM, the Union imposed an upper ceiling on its borrowing limits. And that in the guise of exercise of its powers under Article 293(3) and 293(4), the Union is curtailing its fiscal autonomy. Two letters seem to have been issued by the Union informing Kerala that in view of the amendments to FRBM in 2018, it cannot borrow additional sums, while Kerala is arguing that it needs the additional money to finance its welfare schemes and pay its pensioners among apart from meeting other essential expenditure needs.

This brings us to the question of what is the scope and nature of the Union’s power under Article 293? Article 293, with the marginal heading ‘Borrowing by States’ provides that: 

  • Subject to the provisions of this article, the executive power of a State extends to borrowing within the territory of India upon the security of the Consolidated Fund of the State within such limits, if any, as may from time to time be fixed by the Legislature of such State by law and to the giving of guarantees within such limits, if any, as may be so fixed.
  • The Government of India may, subject to such conditions as may be laid down by or under any law made by Parliament, make loans to any State or, so long as any limits fixed under article 292 are not exceeded, give guarantees in respect of loans raised by any State, and any sums required for the purpose of making such loans shall be charged on the Consolidated Fund of India.
  • A State may not without the consent of the Government of India raise any loan if there is still outstanding any part of a loan which has been made to the State by the Government of India or by its predecessor Government, or in respect of which a guarantee has been given by the Government of India or by its predecessor Government.
  • A consent under clause (3) may be granted subject to such conditions, if any, as the Government of India may think fit to impose.

Article 293 is not a novel provision and had a comparable predecessor in the Government of India Act, 1935. However, the scope and implications of Article 293 have not been truly tested in a dispute before Courts. Nonetheless, it is important to examine if some of the arguments put forth by Kerala are a reasonable interpretation of the text of Article 293. 

To begin with, Article 293(1) provides complete freedom to the State to borrow money ‘within the territory of India’ and any limits on such powers are imposed by the State legislature by a law. To this end, States, including Kerala, have enacted their own fiscal responsibility statutes – State-level FRBMs – which set targets of the fiscal deficit vis-à-vis the GDP of the State. And in enactment of these laws, Article 293 envisages no role of the Union. 

Article 293(2) empowers the Union to extend loans to any State. Also, the Union can extend guarantees in respect of loans raised by any State, subject to satisfaction of the conditions of Article 292 or any law made by the Parliament. In this respect, Article 292 provides that the executive power of the Union extends to borrowing upon the security of Consolidated Fund of India within such limits as may be prescribed by law. And Section 4(1)(c) of FRBM states that the Central Government shall not give guarantees on any loan on the security of the Consolidated Fund of India in excess of one-half per cent of GDP in that financial year. And there is a Guarantee Policy that elaborates the administrative and other aspects of the Union providing guarantees.  

Articles 293(3) and 293(4) – central to the dispute – provide the Union powers to interfere with the State’s autonomy to raise money. Article 293(3) states that the Union’s consent is a pre-condition for a State to raise any loan if the loan granted to it by the Union is still outstanding or if the loan in respect of which the Union was a guarantor is outstanding. The Union can intervene in a State’s attempt to raise more money via loans, but only in the two circumstances mentioned above. 

Article 293(4), at first glance, seem to offer a wide discretion to the Union as its provides that the Union may grant consent under clause (3) subject by imposing  conditions as it ‘may think fit to impose.’ The conditions, if the Union’s response Kerala petition is any indicator, may include macroeconomic stability/financial stability, credit ratings among other related economic considerations. The Union, of course, is responsible for maintaining a stable economic environment at the national level and the Union imposing conditions on State’s borrowing by invoking macroeconomic stability which in turn is influenced by fiscal deficit limits seems to be reasonable. In the absence of any express caveats in Article 293(4), the outer limits of the Union’s discretion will have to be read into the provision. For example, if the conditions imposed by the Union are not unreasonable or arbitrary, they are likely to be within the scope of Article 293(4). At the same time, it is possible to argue that the conditions while reasonable should have a sufficient nexus with the objective of either maintaining or achieving the fiscal deficit targets provided in FRBM- State and Union level. While the outer limits are relatively easier to articulate in abstract and general terms, the true test is applying them to the facts at hand which is easier said than done.   

Kerala’s other argument that amendment of Section 4 of FRBM whereby State debts have been included in the definition of ‘general Government debt’ is beyond the Union’s legislative competence is persuasive. The persuasiveness is because public debt of a State is clearly listed in Entry 43, List II and in pursuance of that power the States have enacted their own FRBMs. The Union can of course, claim that the encroachment on State’s public debt is incidental and the pith and substance of the Union-level FRBM is to set limits for the Union’s fiscal deficit. Or in the alternative, Union-level FRBM is aimed to preserve macroeconomic stability and any encroachment on State public debt is incidental. The counter argument is that what the Union cannot do directly it cannot do indirectly. In the guise of legislating for macroeconomic stability and providing fiscal deficit targets for the Union’s debts, it cannot set ceiling limits on State’s borrowing powers and encroach State’s legislative power under Entry 43, List II.   

Kerala Finance Minister Interprets Article 293 

In a letter dated 22.07.2022, the then Finance Minister of Kerala wrote a letter to the Union Finance Minister expressing displeasure at the Union’s attempt to regulate financial management of the State. The Finance Minister of Kerala stated that Article 293(3) and (4) were only meant to provide the Union power to protect its interest as a creditor and not grant a general power to the Union to oversee the overall borrowing program of the States. While the letter also highlighted the Union’s questionable methods of calculating its debts such as inclusion of debts of instrumentalities of State Government, i.e., statutory bodies and corporations but excluding the public account of the State, I will keep the focus on the Finance Minister of Kerala’s understanding of Article 293.

In the letter, Finance Minister of Kerala argued that the term ‘any loan’ used in Article 293(3) must be interpreted by applying the principle of ‘ejusdem generis’ and can only mean a loan advanced by the Union to States. And that the requirement of obtaining the Union’s consent under Article 293(3) is only for the purpose of protecting the rights of the Union as a creditor. Thereby, the conditions that the Union can impose under Article 293(4) can only be related to the loan for which it issues consent under Article 293(3). 

Finance Minister of Kerala places a restrictive interpretation on the Union’s powers under Article 293(3) and (4). While the argument that ‘any loan’ under Article 293(3) should be interpreted to mean loans by the Union to States is interesting, in the absence of any definitive external aid to interpret this provision it cannot be termed as a decisive understanding of the phrase. The restrictive and purposive interpretation of Article 293(3) and (4) by the Finance Minister of Kerala also seeks to ensure that the Union can exercise its power to provide consent and impose conditions only to protect its interests as a creditor for the outstanding loans and not to regulate the financial borrowings of the State in general. For the latter is within the legislative competence and by extension executive power of the State in question. The restrictive interpretation will thus maintain the delicate balance of distribution of legislative powers.     

Finance Minister of Kerala also brings into question the legislative competence of the Union to regulate the State’s borrowings. The letter states that the executive power of the Union is co-extensive with its legislative power and since Parliament has no legislative power vis-à-vis Article 293 no executive power can be exercised by the Union under the provision. I think there is another way to look at the legislative and executive powers of the Union vis-à-vis public debt of States: since the Union has no legislative power on public debt of a State, it cannot exercise executive power on the same issue except beyond the confines of Article 293(3) and 293(4). Of course, even in this scenario what is exact scope of Articles 293(3) and 293(4) and the nature and extent of the Union’s powers under these provisions will need to be necessarily determined.  

The Argument of Union’s ‘Superior Financial Powers’

Article 293 and the issue of public debt is fairly novel in Indian Constitutional jurisprudence. In such situations, the broader Constitutional design vis-a-vis taxation and financial matters can help understand the extent of Union’s powers under Article 293. As regards taxation, the more lucrative and buoyant tax sources are with the Union though the States bear relatively more administrative responsibilities. Drawing an analogy from division of taxation powers, one of the Union’s initial arguments before the Supreme Court was that the Union is also vested with greater powers in managing finances given its responsibility of promoting macroeconomic stability. The dangers of adopting this interpretive approach are manifold. First, the term ‘macroeconomic stability’ is malleable and all-encompassing and provides wide leeway to the Union. Second, while the greater taxation powers of the Union are evident from the tax-related legislative entries in the Seventh Schedule and GST-related provisions, the case for the Union possessing greater financial powers rests on a contextual reading of the relevant Constitutional provisions. Greater emphasis needs to given to legislative competence of States over their public debts vis-à-vis the Union’s powers under Article 293(3) and 293(4). As far as possible, the division of financial powers need to be understood and interpreted on their own terms. If the Constitutional design on taxation powers becomes the springboard for interpreting the financial powers in a similar manner, States will have to contend with the Union imposing strict conditions before raising loans and more intrusive scrutiny of their borrowing powers.  

Conclusion 

Kerala has raised important Constitutional and legal questions through its petition and its satisfactory resolution will require, among other things, an adept understanding of the Constitutional design and importance of finances in the Union-State relations. Majority of fiscal federalism discussions in India have centred around the devolution of taxation powers with little to no attention to the borrowing powers. Even though successive Finance Commissions have dealt with the subject they have not opined specifically on the scope and meaning of Article 293. The distribution of financial powers especially relating to borrowings has never been truly discussed in a meaningful manner nor has it been tested before Courts. It is possible that the Union and Kerala may resolve this disagreement outside the Court, but irrespective the latter’s petition presents interesting questions that may throw equally interesting or surprising answers.      

Article 293 of the Constitution vis-a-vis Section 163, GOI, 1935

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The infographic compares Article 293 of the Constitution with its predecessor provision, i.e., Section 163, Government of India Act, 1935. The differences are highlighted via the underlined text in grey. A detailed examination of Article 293 in the backdrop of the Kerala and Union’s pending dispute before the Supreme Court can be read here.

JDAs Not Exempt from GST: Telangana HC

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The Telangana High Court in a recent judgment clarified that Joint Development Agreements (‘JDA’) between developer and landowner do not transfer ownership rights but only grant development rights to developer. The petitioner’s case, in summary, was that JDA results in transfer of ownership in land and the GST exemption for ‘sale of land’ under Entry 5, Schedule III, CGST Act, 2017 will be applicable to JDAs. The State’s case for bringing JDA within the fold of GST relied on Entry 5(b), Schedule II, CGST Act, 2017 which inter alia makes construction services amenable to GST.  The High Court clarified that transfer of ownership only takes place via a conveyance deed after the developer has completed the obligations under JDA, and JDA itself does not transfer title in the land.  

Facts and Arguments 

The petitioner claimed that the transfer of development rights in its favor by the landowner via JDA should be treated as sale of land by the landowners and the execution of JDA should not be subjected to GST. 

The petitioner’s arguments were that the execution of JDA was ‘almost like a sale of land’ and that JDA needs to be considered holistically without focus on individual clauses as it enabled the landowner to transfer the land to the petitioner. The petitioner’s case was that by execution of JDA itself there is substantive transfer of development rights in favor of the petitioner which results in sale of land proportionate to the amount of investment made by the developer. And since JDA gives rise to an element of sale of land the statutory embargo on levy of GST on sale of land would be applicable. 

The petitioner’s ancillary argument was that Notification via which GST was imposed on transfer of development rights should be declared as ultra vires the Constitution. The petitioner’s argued that the Notification traversed beyond the four corners of the law. The absence, in CGST Act, 2017, of any specific provision, mechanism or machinery to determine the quantum of tax payable on JDA was emphasised to argue that the Notification being a delegated legislation traversed beyond the parent legislation.  

The State contended that the petitioner’s entire case lacked any foundation. The State referred to the clauses of JDA to argue that ownership, title rights on the land were retained by the owner and the petitioner was only granted the development rights on the land which belonged to the landowner. The State added that none of the clauses of JDA indicate that the JDA which gives petitioner right to develop the property also effectuates an outright sale of land from the landowner to the petitioner. 

Telangana High Court Decides 

The Telangana High Court correctly rejected the petitioner’s arguments and concluded that execution of JDA does not result in an outright sale of land. The High Court’s conclusion was primarily dependent on its examination of the terms/clauses of JDA and their implication.  

The Telangana High Court opined that an owner of immovable property has a bundle of rights one of which is to get the property developed by an agent of its choice on the terms and conditions that they deem fit. The High Court noted that under the JDA, the petitioner would get the licence/permission to enter the landowners’ property for execution of its development activities. And after the petitioner develops the entire property, the landowner would grant to the petitioner a share in the land proportionate to the built-up area for which petitioner is entitled. (paras 24 and 25) 

The Telangana High Court also noted that the JDA clearly stipulated that in event of default on the petitioner’s part, all the rights on the property remained with the landowner. This stipulation in favor of the landowner, as per the High Court, was an indication that the title over the property on the date of execution of JDA remained with the landowner and not with the petitioner. (para 26) 

The Telangana High Court referred to another clause of JDA which stipulated that on completion of development, the petitioner was to transfer possession of the completed units to the landowner. Thereafter, the landowner would sign conveyance deed with the petitioner to transfer the undivided share of land towards investment, efforts, cost of construction incurred by the petitioner in developing the land. The High Court correctly interpreted the terms of JDA to note that under a JDA, the petitioner offered construction services to the landowner. And for the said services the landowner transferred development rights to the petitioner and the same cannot be equated with outright sale of land. Based on the above reading of the various clauses of JDA, the High Court concluded that:    

From plain reading of the JDA that was entered into between the two parties, what is apparently visible is that, there was no outright sale of land being effectuated and the JDA per se cannot be considered merely as a medium adopted by the landowner selling his land and the JDA does not lead to sale of land by itself. After the entire development activities are carried out for the investment made by the petitioner for realizing what he has invested, he would be permitted to sell/dispose of certain developed properties constructed in execution of the JDA. (para 29)

The High Court further reinforced its conclusion by observing that the transfer of undivided land in favor of the petitioner only happens after issuance of the completion certificate indicating that the services rendered by the petitioner in execution of JDA were supplied prior to issuance of competition certificate and were amenable to GST. The High Court was here impliedly referring to Entry 5(b), Schedule II, CGST Act, 2017 which makes construction services amenable to GST when they are provided before issuance of completion certificate. 

As regards the petitioner’s challenge to the validity of Notification, the High Court noted that Notification does not create a charge but only states the time at which the GST is payable is when the developed area is transferred by the petitioner to the landowner and not at the time of execution of JDA. And the Notification did not suffer from the vice of excessive delegation.  

Conclusion 

The Telangana High Court’s interpretation and understanding of JDA is correct. The petitioner’s contention that execution of JDA itself transfers ownership rights was incorrect as the various stipulations in JDA made it evident that the transfer in title only happens once the developer has fulfilled the obligations of developing the land in question. The petitioner erroneously equated the right to receive a part of the land on completing the development of land with the actual transfer of land. 

Lessons from NAA: Parameters of a Fair Dispute Resolution Body 

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The experience of transitioning from retail sales tax to VAT laws in 2002-03 provided a learning that a similar transition to GST may be used as a pretext by suppliers to artificially increase the prices of goods and services and profiteer at the expense of retail consumers. To protect consumer interest, an anti-profiteering provision was included in Section 171 of the CGST Act, 2017 which mandates that any reduction in tax rate or the benefit of ITC shall be passed on to the consumer by way of commensurate reduction in prices. And under the same provision the Central Government was empowered to either notify an existing authority or create a new authority to implement the mandate. And a new body in the form of National Anti-Profiteering Authority (‘NAA’) was duly constituted to implement the mandate of Section 171.  

NAA’s constitution via delegated legislation, opaqueness about its methodology to determine profiteering, absence of an appellate remedy, and the rhetoric filled nature of its orders created fertile grounds for arguments that it was an unconstitutional body. Recently, the Delhi High Court upheld the constitutionality of NAA though it provided the petitioners the liberty to challenge the individual orders of NAA on merits. I’ve previously examined the limitations and flaws in the judgment. In this article, I rely on NAA’s working and the Delhi High Court’s judgment to extrapolate some parameters which should be the touchstone to examine the efficacy and fairness of a tax dispute resolution body. 

Providing Appropriate Policy Guidance  

A crucial issue that characterises the administration of tax laws in India is the nature and extent of delegated legislation. Statutory provisions are consistently interpreted, re-interpreted by the executive via Circulars, Notifications, and Press Releases which are also constantly issuing instructions that require attention and compliance by taxpayers. The content of several such secondary legislative instruments is not only far removed from the parent statute, but the policy is also rarely encoded in the statute. The issue of delegated legislation, and its legal scope, becomes even more acute when the statute does not provide adequate policy guidance to the decision-making body creating a danger of the body interpreting its mandate beyond the confines of the parent statute. And more crucially, leaving the stakeholders clueless about the scope of jurisdiction of the decision-making body and the nature of disputes that it can adjudicate. 

The fact that NAA did not contain adequate policy guidance was one of the petitioner’s main contentions before the Delhi High Court and rightly so. While Section 171 does state the broad compliance that suppliers need to adhere, it provides no insight into the nature and scope of of the body that is empowered to implement the mandate. NAA’s and the Delhi High Court’s opinion was that Section 171 is a ‘self-contained code’; but, interpreting the broad mandate of Section 171 as an adequate policy direction is not ideal. Certainly not from the perspective of taxpayers. The jurisdiction and mandate of the decision-making body needs to be prescribed more precisely and preferably by the legislature or executive. The body in question should not have the authority to determine its own jurisdiction and procedure which it can interpret in a self-serving manner. 

Creating an Accountability Mechanism

Creating accountability mechanisms for judicial or quasi-judicial bodies has been a tough road in India. For example, we are yet to determine the appropriate method and manner of determining the accountability of judges of High Courts and the Supreme Court. One way the accountability invariably gets attached to judicial or quasi-judicial bodies is through the process of appeals against their orders. It allows the petitioner an opportunity to make additional or better arguments, at the same time another body can scrutinize the order on the touchstone of fairness, interpretive coherence, and other similar parameters. In the absence of a statutory right to appeal for the parties, the risk of perverse orders and opaque functioning increases dramatically. For example, in NAA’s case the parties were not provided a statutory right to appeal against its orders and could only approach the High Court via writ petitions which is accompanied with its own limitations. NAA could only be supervised by the GST Council, which if the minutes of its meetings as anything to go by, treated its job of supervising NAA superficially.  

One consistent and oft-repeated theme in NAA’s orders was the taxpayers demanding that NAA makes its methodology for calculating profiteering public and NAA replying that it had issued a document – which actually did not state the methodology – and regardless, calculating amount of benefits that needs to be passed to customers wasn’t a tough or complex task and taxpayers could do it themselves. And yet when taxpayers challenged NAA’s constitutionality on the ground that it lacked a judicial member, etc., NAA replied that it was an ‘expert body’ involved in complex work of determining profiteering and need not be compared to quasi-judicial or judicial bodies. Opaqueness and inconsistencies in NAA’s orders were abound but there was no superior or appellate authority that could scrutinize its decisions and present and alternate or a modified view of the facts and dispute in question. It is one thing to say that the constitutionality of a body cannot be challenged on the ground that there is no right to appeal against its orders, but the implications of the absence of such a right extend beyond the constitutionality argument and tax administration needs to be mindful of them.    

Defined Identity as an Adjudicatory Body or a Regulator  

Taxation law primarily concerns itself with the relationship of State with its residents with the former exercising its coercive power to extract financial resources for its sustenance. The disputes about the scope of the State’s powers are typically adjudicated by classical dispute resolution bodies, mostly successfully. In mediating the relationship of the State and its residents qua their tax obligations, the need for a regulator rarely presents itself. Thus, while sectoral regulators in other spheres such as banking law, securities law, etc. is relatively common, we do not witness similar bodies in tax law universe. Irrespective, when novel or ‘atypical’ bodies are created for administration of tax laws, it is incumbent on the legislature to be precise in stating the rationale and need for the body. Else, not only are the stakeholders confused, but the ‘atypical’ body itself suffers from an identity crisis and looks to fulfil the mandate of both a traditional dispute resolution body and a sectoral regulator and is frequently unable to do justice to neither.

In the case of NAA, it is still unclear if it was intended to be a dispute resolution body or a regulator. But one thing we do know that NAA fancied itself as an expert body and a sectoral regulator and frequently drew analogy of its mandate with SEBI. The analogy was always flawed because SEBI is creation of a dedicated statute, has a Board, and separate dispute resolution bodies while NAA, created via delegated legislation, was a coalesced body consisting of a few technical members which adjudicated on disputes and complaints relating to profiteering. The investigate arm of NAA, DGAP, was answerable and bound by all directions of NAA removing all and any pretence of checks and balances in its operation. There was no clear identification of its role beyond the general mandate contained in Section 171 and NAA itself did not satisfactorily fulfil the role of either a regulator or a dispute resolution body.    

De Minimis Requirement of Reasoned Orders 

In respect of taxation law, the absence of well-reasoned orders is a widespread symptom that affects advance ruling authorities, tribunals and to some extent even High Courts and the Supreme Court. While speaking orders are a minimum requirement or at least an expectation from any judicial or quasi-judicial or for that matter any administrative body, there is a need to ensure that the orders satisfy the minimum standards of a reasoned order. This can be done through careful selection of personnel and/or ensuring accountability mechanisms in form of an appellate body as suggested above. 

While people like me and more skilled than me examine and critique the various such orders, there was something fundamental amiss in the NAA’s orders: skill of writing a judgment. The Delhi High Court in its recent judgment has incorrectly noted that NAA was only a fact-finding body and did not adjudicate on rights and liabilities. NAA not only heard arguments of the taxpayers who were defending their conduct, but also of complainants, and adjudicated on their rights and obligations. But in most of its orders, one found a lack of engagement with the various arguments that the parties raised and instead a generous dose of rhetoric, stonewalling, and sidestepping with substantive arguments. NAA interpreted the relevant statutory provisions were interpreted pedantically and did not even acknowledge important arguments when arriving at its conclusions, violating basic tenets of judgment writing. It is important that vital tax law matters are not decided in a whimsical fashion with disregard to taxpayer rights and a well reasoned judgment is provided by the authorities in question.  

Conclusion 

The above are by no means exhaustive or even necessary conditions to design a fair and transparent tax dispute resolution body. I’ve only picked cues from the working of NAA and the arguments presented by petitioners before the Delhi High Court to make a tentative case for designing dispute resolution bodies under the tax law umbrella. I’ve highlighted some of the above parameters based on my own previous assessment and observation of the NAA’s working and how, in my view, there was a wide bridge between the laudable objectives of setting up an anti-profiteering regime under GST and the NAA implementing the said mandate in an opaque manner via questionable orders that barely met the minimum requirements of respecting taxpayer rights and administering tax justice.  

Penalties for e-way bills cannot be imposed in absence of Mens Rea: Allahabad HC

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The Allahabad High Court in a recent judgment took the view that the GST Department cannot impose a penalty on taxpayers – under Section 129(3), CGST Act, 2017  – for not possessing e-way bills in the absence of an intention to evade tax. The High Court held that the essence of any penal imposition is linked to the presence of mens rea which was clearly absent as revealed from the facts and records of the impugned case. In stating so, the High Court aligned with an emerging jurisprudence on Section 129 that requires intent to evade tax as an essential requirement for passing orders under Section 129(3). 

Facts  

The petitioner, an authorized dealer of Steel Authority of India Ltd (‘SAIL’) purchased a bar of TMT on 19.02.2021. Tax invoices were issued by SAIL to the petitioner, and they contained the registration number of the transportation vehicle. The petitioner claimed that the e-way bills could not be generated at the onset of transportation since there were glitches in the e-way bill system of the Department. The e-way bills were generated on 20.02.2019 and 21.02.2019. The petitioner’s claim was that the e-way bills were presented at the time of interception of goods before the issuance of showcause notice and before passing the detention order. Aggrieved by the orders of detention passed on 21.02.2019 and 20.10.2019 by the Assistant and Additional Commissioner respectively, the petitioner approached the Allahabad High Court. 

Allahabad High Court Quashes Orders of Detention 

The Allahabad High Court noted that the relevant question was: despite the petitioner failing to generate the e-way bills on time, did it have an actual intent to evade payment of tax? The High Court cited relevant precedents to note that for proceedings under Section 129(3) intent to evade tax is mandatory and that even in the absence of an e-way bill if there is no discrepancy in the accompanying documents and no intent to evade tax, then penalty cannot be levied. Courts have also held that not generating Part B of the e-way bill is a mere technical error, and if the accompanying invoice has the vehicle details, then it can be reasonably concluded that the taxpayer has no intent to evade tax. Based on an examination of the relevant precedents, the High Court’s summation of the current legal position was: 

What emerges from a perusal of the aforesaid judgments is that, if penalty is imposed, in the presence of all the valid documents, even if e-Way Bill has not been generated, and in the absence of any determination to evade tax, it cannot be sustained. (para 15) 

As per the facts of the impugned case, the petitioner had generated both the e-way bills, one before detention and one after detention, but both before the order under Section 129(3) was passed. The Allahabad High Court noted, neither of the two orders contained a reasoning as to how and why an intention to evade tax was established. The High Court noted that the petitioner was made to suffer due to a technical error without there being an intent to evade tax on petitioner’s behalf. Elaborating on the importance of establishing intent to evade tax before imposing penalties under Section 129(3), CGST Act, 2017, the High Court observed: 

A penal action devoid of mens rea not only lacks a solid legal foundation but also raises concerns about the proportionality and reasonableness of the penalties imposed. The imposition of penalties without a clear indication of intent may result in an arbitrary exercise of authority, undermining the principles of justice. Tax evasion is a serious allegation that necessitates a robust evidentiary basis to withstand legal scrutiny. The mere rejection of post-detention e-Way Bills, without a cogent nexus to intention to evade tax, is fallacious. (para 18) 

The Allahabad High Court further added that it was incumbent on the tax authorities to distinguish technical errors from deliberate attempts to avoid tax. And that mere technical errors that do not have financial implications should not lead to imposition of penalties. 

Conclusion 

The Allahabad High Court through its judgment in the impugned case follows a line of judicial precedents – and the High Court duly cited some of them – that underline the need to establish or indicate the presence of intent to evade tax before tax authorities pass an order under Section 129(3) of CGST Act, 2017. Either the officers are not understanding the scope and objective of the provision or are deliberately ignoring the requisite conditions of the provision before passing orders under Section 129(3). Irrespective, the burgeoning no. of cases by taxpayers claiming violation of Section 129(3) indicates a lack of adherence to the law laid down by Courts in an increasing no. of cases.  

Post-Supply Discounts Cannot be Included in Transaction Value: Madras HC

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The Madras High Court recently observed that post-supply discounts offered by a supplier to the recipient cannot be included in the transaction value/value of supply for levying GST. The High Court distinguished between subsidy offered by a third party and a discount and noted that a discount by itself cannot qualify as subsidy.  

Introduction to Taxability of Discounts under GST  

Before discussing the case, I think it is important to provide contest of the type of discounts envisaged under CGST Act, 2017 and their manner of inclusion and exclusion from the value of supply. 

Section 15, CGST Act, 2017 contains stipulations as to which amounts can or cannot be included in the value of a taxable supply, where both the recipient and supplier are not related, and price paid or payable is the sole consideration for supply. Section 15(3)(a) states that discounts offered at the time of or before a supply shall not be included in the value of supply in such discount has been duly recorded in the invoice in respect of such supply. Section 15(3)(b), which was in focus in the impugned case, states that a discount after a supply has been effected shall not be part of value of supply if: (i) such discount is established in terms of agreement entered into at or before the time of such supply and specifically linked to relevant invoices; (ii) ITC as is attributable to the discount on the basis of the document issued by the supplier has been reversed by the recipient of the supply. 

Typically, discounts offered before or at the time of supply are excluded from the value at the time of generation of invoice itself. While discounts offered after the supply cannot, due to their nature be reflected in the invoice per se, but the value can be reduced by filing credit notes thereafter and linking it to the supply in question. It is the latter kind of discount that was the Madras High Court’s focus in the impugned case.  

Facts and Arguments  

The facts of the impugned case were not clearly stated by the Madras High Court in its judgment, but from what one can gather it seems: the petitioner challenged the inclusion of volume discount in the value of supply and the Revenue Department’s stance that the discount was a ‘private’ subsidy. Under Section 15(2)(e) subsidies directly linked to the price are included in the value of supply except subsidies provided by the Central and State Governments. The petitioner’s case was that it paid GST on the transaction value in the invoice which includes the volume discount, and the Revenue Department cannot add the volume discount over and above the invoice amount as it would to double taxation on the same amount. The petitioner contended a manufacturer would incentivize the distributors to sell mobile phones on a discount and such discount cannot be construed as a subsidy under Section 15(2)(e). 

The Revenue Department seems to have added the discount value to the invoice by claiming that the discount is a subsidy by a third party and amounts to consideration under Section 2(31)(b), CGST Act, 2017. The Revenue Department’s order under challenge before the High Court also mentioned that the after-supply discount must be as per the terms agreed and based on certain parameters and workable criteria. And a discount cannot be offered at the complete discretion of the supplier. The Madras High Court held that the order was unsustainable in law and liable to be quashed. 

Madras High Court Decides 

The Madras High Court made three observations that were vital to the dispute and are our understanding of when post-supply discounts can or cannot be included in the value of supply: 

First, the High Court observed that Section 15(2)(e) of CGST Act, 2017 will only come into play when a part of the consideration payable for the supply is subsidized by third party other than the Central Government or the State Government. While this is a straightforward interpretation of the impugned provision, it is a necessary clarification for frequently some basic and obvious things need to be made clear to the Revenue Department. (para 45)

Second, the High Court observed that a subsidy will be embedded in the transaction value only if it disguised as a discount. However, a discount by itself will not qualify as a subsidy. (para 48) A discount will only be part of the transaction value if it is on account of a subsidy offered by a third party. The High Court was trying to distinguish the discount offered by a supplier on their own account and a discount offered due to contribution by a third party; the latter being a ‘private’ subsidy that was liable to be included in the value of supply and the former being a discount that as per Section 15(3)(a) and/or Section 15(3)(b), whichever is applicable, not being part of the value of supply. While this an important distinction, it still leaves open the question of how a discount is to identified and distinguished from a ‘private’ subsidy. We do know that a discount does not by itself become a subsidy, but we don’t know when they transform into a subsidy. 

Third, the High Court stated the discount can only impact the transaction value of the supplier and its recipient. And there is no scope for confusing the further supply made by the recipient and the sale it effected to its customers and the discount it offered. (paras 51-52) 

As I stated above, the High Court did not narrate the facts clearly, so it is difficult to understand some of its observations especially the third observation listed above. But, after reading the judgment, it does seem that in this case this is what transpired: 

A supplied goods to B, which included the price of volume discounts and GST was calculated by including the value of volume discounts. When B further supplied those goods to C on a discounted value, the Revenue Department included the discount value offered by B in the transaction value of supply made from A to B contending that the discount offered by B to C was a subsidy provided by A to B. This not only caused the possibility of double taxation of the discount, but also inter-relating two different supplies and not treating them independent of each other. The value of supply from A to B was calculated in reference to the value of supply from B to C and the High Court frowned on the same. 

Conclusion 

The Madras High Court’s judgment is succinct on its findings on law and almost equally precise on the facts, though the latter lack clarity which is an impediment to completely understanding its approach to the underlying dispute. Despite the hiccups in comprehension, the High Court’s findings on law are welcome and clarify an important aspect on the GST implications of discounts and their impact on the value of supply.             

Supply of Vouchers and GST: Three Decisions and a Defensible Conclusion

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This article focuses on the issue raised by M/s Kalyan Jewellers Limited (‘Kalyan Jewellers’) as regards the pre-paid instruments (‘PPI’)/vouchers issued by them to their customers. The claim of Kalyan Jewellers before the Advance Authority (‘AAR’), Appellate body for Advance Rulings (‘AAAR’), and thereafter before the Madras High Court was that the PPIs/vouchers issued by them were actionable claims. And due to the exemption of actionable claims under Schedule III of the CGST Act, 2017, the supply of PPIs was not subject to GST. Section 2(1) of CGST Act, 2017 defines actionable claims to have the same meaning as assigned to them under Section 3 of Transfer of Property Act, 1882 which inter alia defines it as a claim to any debt other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property. And Schedule III of CGST Act, 2017 – as it existed then – stated that actionable claims, other than lottery, betting and gambling shall neither be treated as supply of goods nor supply of services. AAR, AAAR, and the Madras High Court all three adopted varied perspectives on the issue, and I examine all three below.     

AAR and AAAR Adopt Different Perspectives 

PPIs issued by Kalyan Jewellers directly or through third party vendors could be redeemed at any store of Kalyan Jewellers across India. PPIs were purchased by customers by paying a value of money specified on the PPI, and on payment the value was loaded on the PPI. And the customers could redeem the PPI against purchase of any jewellery in any of the outlets of Kalyan Jewellers. Kalyan Jewellers’ claim was that GST was only attracted when customers redeemed their PPIs, since the goods were sold at the time of redemption of PPIs and not at the time of supply of PPIs.

AAR observed that if the customer loses the PPI or is unable to produce it before expiry it cannot be used to purchase any goods. Based on the limited use of PPI, AAR concluded that PPI was not an actionable claim but only an instrument accepted as consideration/part consideration while purchasing goods from a specific supplier whose identity was established in the PPI. AAR held that PPIs constitute vouchers as defined under Section 2(118) of CGST Act, 2017 which states as follows: 

“voucher” means an instrument where there is an obligation to accept it as consideration or part consideration for a supply of goods or services or both and where the goods or services or both to be supplied or the identities of their potential suppliers are either indicated on the instrument itself or in related documentation, including the terms and conditions of use of such instrument; 

Relying on the above definition, the fact that PPI belongs to the customer who purchases it and is allowed to redeem it, AAR concluded that PPIs issued by Kalyan Jewellers are neither money nor actionable claims. And since other ingredients of a supply were fulfilled, the issuance of PPIs constituted as a supply.

The remaining question was that of time of supply, i.e., should GST be payable at the time of issuance of vouchers or at the time of their redemption by the customers? Time of supply where vouchers are involved is mentioned in Section 12(4), CGST Act, 2017 where it is stated that the time of supply shall be the date of issue of voucher, if the supply is identifiable at that point; or the date of redemption of voucher in all other cases. And since PPIs were redeemable against any jewellery, the time of supply in this case was held to be at the time of redemption of PPIs.     

Kalyan Jewellers filed an appeal before AAAR on the ground that PPIs only had a redeemable value but no inherent value capable of being marketable for the purpose of levy of GST. Kalyan Jewellers repeated its argument that PPIs are not actionable claims or goods and if their supply is subject to GST it would amount to double taxation since GST would also be paid at the time of supply of jewellery. AAAR adopted an interesting to determine the issue. AAAR held that PPI in question was neither a good nor a service, but it was not necessary to arrive at a determination if it was an actionable claim. 

AAAR categorized the PPI as a voucher, like AAR’s approach, but added its own observations. AAAR held that voucher is just means of an advance payment of consideration and per se it is neither a good nor a service. (para 7.9) It clarified that there was no issue of double taxation for if GST was levied at the time of issuance of PPI no GST would be payable at the time of its redemption. And whether supply of PPIs is taxable at the time of their supply or their redemption would be determined by the fact if the underlying supply is identifiable at that point. AAAR concluded that since the PPIs mentioned that they can be redeemed against gold jewellery at a known rate of tax, they were taxable at the time of their supply. (para 7.11) And since the PPI was neither a good or a service, it was classifiable as per the goods or services supplied on its redemption.      

It is interesting to note that Kalyan Jewellers was insistent that their PPIs be classified as actionable claims and not be subject to GST at the time of their supply but only at the time of their redemption. AAR and AAAR pretty much sidestepped the issue of actionable claim. Both the AAR and AAAR made one common observation, and in my view correctly so, that PPIs satisfied the definition of voucher and were means of consideration, treating the issue of whether PPIs were actionable claims as incidental and almost unnecessary. 

Madras High Court Goes a Step Ahead 

One would assume that AAAR’s succinct and accurate identification of PPI as vouchers would end the matter of taxability of PPIs issued by Kalyan Jewellers; but, that was not to be. Kalyan Jewellers appealed AAAR’s appealed before the Madras High Court and made similar arguments and claims it made before AAR and AAAR, i.e., PPIs issued by it were actionable claims and were subject to GST only at the time of their redemption and not at the time of their issuance. (paras 12-13) 

Madras High Court went a step further than both AAR and AAAR to interpret the definition of voucher, actionable claims and debt in significant detail and referred to the relevant provisions of Transfer of Property Act, 1882, General Clauses Act, 1897 and the Educational Guide issued under Finance Act, 1994. The High Court concluded that the PPIs issued by Kalyan Jewellers were a debt instrument as they acknowledged debt and could be redeemed on a future date towards sale consideration on purchase of any merchandise from the Kalyan Jewellers outlet. And if Kalyan Jewellers refused to redeem the value of PPI, the customer would have a right to enforce. 

Another factor that influenced the Madras High Court’s conclusion that PPI was an actionable claim was its attention to the fact that while the PPIs issued by Kalyan Jewellers mentioned that the customers would not be entitled to refund if PPIs expire before redemption, the said condition was not in accordance with RBI’s Master Directions on PPIs. The High Court clarified that even if the PPI expires before the customer claims refund, the customer would be entitled to claim refund. Accordingly, the High Court clarified that:

The “Gift Voucher/Card” is a debit card. It is like a frozen cash received in advance and thaws on its presentation at the retail outlet for being set off against the amount payable by a customer for purchase of merchandise sold by the petitioner or the amount specified therein is to be returned to the customer as per RBI’s Master Direction where a customer fails to utilize it within the period of its validity. (para 72)  

While the Madras High Court held that the PPI was an actionable claim, it also partially endorsed the AAAR’s approach that there was no need to determine if the voucher was an actionable claim to conclude that it was neither a good nor a service. As per the High Court it was sufficient to state that since PPIs were actionable claims, they were ‘as such’ not liable to taxation themselves, but only the underlying transactions were taxable. Here again, the implication of PPIs being not liable to GST as such is not clear, since PPIs are anyways liable to tax only in reference to the supply of goods or services that they facilitate. So while the High Court did finally endorse PPIs as actionable claims, it did not, and as per me, will not materially affect their taxability.    

Finally, the High Court’s conclusion was correct as it clarified that the PPI/voucher being the means of consideration could not be subject to GST, but only the goods or services purchased via it were taxable. Of course, presuming the other prescribed ingredients of supply were satisfied. (paras 79-80) As regards the time of supply, the High Court’s opinion was similar to that AAR and AAAR and there was no substantial change i.e., if goods were identifiable at the time of supply of vouchers that would constitute as time of supply else time of supply would be the date of redemption of vouchers. 

Is the Dust Settled on GST Implications of Vouchers? 

Has the Madras High Court’s opinion finally settled the dust on PPIs and their status as actionable claims under GST? I doubt it. The High Court in its decision cited the Karnataka High Court’s decision in M/s Premier Sales Promotion Pvt Ltd, where the latter made two observations that are slightly at odds with the impugned decision. The Karnataka High Court observed that PPIs do not have any inherent value of their own but are instruments of consideration and would fall under the definition of money under CGST Act, 2017. And money has been specifically excluded from the definition of both goods and services. (para 16) Second, the Karnataka High Court held that the issuance of PPIs was akin to a pre-deposit and their issuance did not amount to supply. (para 22) The Madras High Court cited the latter observations of the Karnataka High Court. (para 96) But, the Madras High Court never indicated if it agreed or disagreed with the Karnataka High Court’s approach. And, the difference in opinion of both the High Courts raises the question if PPIs are better classified as money or actionable claims?  

One way to understand this issue is by viewing vouchers as a sub-category of money. Vouchers serve the purpose of consideration or part consideration for goods or services while money, in its traditional form, also performs the same function. PPIs are also typically instruments or forms of consideration. And since PPIs also typically contain identities of suppliers, they tend to satisfy all ingredients of a voucher as in the impudnged case and are better understood as such. While the current divergence between the two High Courts on the actual character of PPIs, did not create any immediate implications in both cases, since both money and actionable claims are outside the purview of GST per se. The divergent interpretations of both the High Courts may present hurdles going forward and will require some reconciliation. 

Conclusion 

On balance, the Madras High Court’s decision is well-reasoned and, in my view, correctly identifies the status of PPIs. The High Court could have, like the AAAR chosen to not adjudicate on the issue of whether PPIs constitute an actionable claim, since the point of their taxability could have been decided only by a reference to the definition of vouchers. However, it scrutinized the key phrases and referred to various legislations and arrived at a justifiable conclusion creating a solid anchor for jurisprudence on the issue of GST implications of PPIs. 

NAA is Constitutional, Individual Orders Can be Challenged on Merits: Delhi HC

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Introduction 

This post focuses on the Delhi High Court’s recent judgment upholding the constitutionality of NAA, a statutory body established under Section 171, CGST Act, 2017. I’ve examined the working of NAA in detail here and here, where I’ve highlighted the problematic aspects of NAA’s various orders. In this post, I will summarize the petitioner’s arguments and the State’s response. At the outset, it is important to highlight that NAA’s functions and powers have been transferred to Competition Commission of India w.e.f. 01.12.2022. While the petitions challenging the constitutionality of NAA have been pending before the Delhi High Court for a while now, a decision on the constitutionality of NAA after it has passed hundreds of orders and has practically ceased to function is also an instance of how tax justice for taxpayers is elusive and littered with delays, even under a ‘transformative’ and ‘game changing’ legislation such as GST.  

The Delhi High Court, in upholding the constitutionality of NAA, has not broken any new ground. In fact, it has blunted various persuasive arguments of the petitioner’s by choosing to adopt a pedantic and literal interpretive approach that saves the face of NAA and paves path for almost unfettered delegated legislation in tax legislations. The High Court has used similar vocabulary as NAA deployed in its orders to defend its constitutionality. The High Court has floundered in engaging with the true import and scope of petitioner’s arguments and instead has provided them the concession of challenging the NAA’s individual orders on merits which is at best a half-baked solution to a constitutional challenge. 

The centrepiece of the petitioner’s case was that Section 171, CGST Act, 2017 and Rules 122, 124, 126, 127, 129, 133, 134 of CGST Rules, 2017. The notices and orders of NAA imposing penalties on taxpayers were also challenged, but the constitutional validity of the aforesaid provisions was the main subject of the impugned decision. And the constitutionality of the provisions and the related arguments also are the focus of this post.  

Section 171(1), CGST Act, 2017 states that any reduction in rate of tax on any supply of goods or services or the benefit of input tax credit shall be passed on to the recipient by way of commensurate reduction in prices. Section 171(2) empowers the Central Government, on recommendations of the GST Council, to constitute an authority or empower an existing authority to examine if the mandate of sub-section (1) is being followed by the registered taxpayers. It was in exercise of its powers under Section 171(2) that the Central Government constituted NAA.        

The relevant Rules under challenge inter alia provided that NAA shall consist of one Chairperson and four technical members, it shall have the power to determine the procedure and methodology to determine if the mandate of Section 171(1) is being adhered to, amongst other relevant details about initiation and conduct of proceedings by NAA. 

Arguments 

The petitioner’s arguments traversed a wide array of issues. The challenge to Section 171 involved arguments that Section 171 prescribed a financial extraction akin to a tax which cannot be levied via subordinate legislation; Section 171 suffered from the vice of excessive delegation as it delegates essential legislative functions to the Government and contains no legislative or policy guidance as to how NAA is to exercise its powers; and further while Section 171 delegates to the Government the power to determine the powers of NAA, the Government via Rule 126 has further delegated to the NAA the power to determine the methodology and procedure to adjudicate on violation of Section 171. The petitioners also contended that the term ‘commensurate’ has not been defined under Section 171 and meaning of profiteering hinges on the phrase ‘commensurate reduction in prices’ resulting in a circular reasoning in the provision. Section 171 was accordingly challenged as being violative of Article 14 and 19(1)(g). 

The other leg of challenges involved the opaque and uncertain methodology adopted by NAA in determining the violation of Section 171. And that in the absence of any legislative guidance, NAA acted arbitrarily demanding taxpayers reduce prices without disclosing specifics of its methodology. The petitioner highlighted the methodology adopted by NAA in profiteering complaints involving real estate companies to underline the arbitrariness in NAA’s approach. The petitioner also compared India’s anti-profiteering mechanism with that of Malaysia and Australia to underline their argument that the anti-profiteering mechanism in India was a price control mechanism interfering with their right to determine prices of goods and services.  

Petitioners further highlighted that there was no time prescribed for taxpayers to reduce prices, there was no judicial member in NAA even though it performed a quasi-judicial function, taxpayers did not have a statutory right to appeal against NAA’s orders. And that NAA did not allow any other method to pass on benefits of reduced taxes except via reduction in prices. For example, altering the sizes of products to pass on benefits of reduced taxes to customers had been rejected by NAA except in one case. 

The State justified the legal framework of NAA as constitutional. The arguments were, to a large extent, comparable to the rhetoric that NAA deployed in its orders in justifying its constitutionality. Some of the arguments that the State adopted were: Section 171 was enacted in pursuance of the Directive Principles of State Policy under Articles 38, 38(b), and 38(c) which inter alia mention economic justice and prevention of concentration of resources in a few hands. Section 171 was within the legislative competence of the Union under Article 246A of the Constitution. The State interpreted Section 171(1) differently from that of the petitioners and argued that it provided amply policy direction. It was argued that Section 171(1) clearly states that ‘any reduction’ in tax rates must be passed to recipients by ‘commensurate reduction in prices.’ And that only minutiae had been left for delegated legislation. The State defended NAA’s powers to determine the procedure and methodology stating that it clearly flows from Section 171 and this not a case of excessive delegation.

The State also challenged petitioner’s argument that only reduction of prices cannot be the sole method via which the taxpayers can adhere to the mandate of Section 171. The State argued that taxpayers should be allowed to ‘only’ reduce price in compliance of Section 171 and NAA is justified in interpreting the provision which is least prone to tax avoidance as allowing other methods may involve manipulation by taxpayers. 

The State argued that Section 171 did not provide for a price control mechanism as argued by petitioners and it only influenced the indirect price component and did not restrict the freedom of suppliers to determine the price. And that NAA was only indulging in fact finding exercise and absence of a judicial member was not fatal to its orders. Neither can absence of a time for which taxpayers are to maintain reduced prices can be the basis of challenging the constitutionality of NAA. 

I’ve tried to summarise the important arguments raised by both sides; but, in my view, the core challenge was of excessive delegation. Section 171 does not provide legislative and policy guidance to NAA and Rule 126 questionably allows NAA to determine its own procedure and methodology, a methodology which the State argued it ‘may’ determine but was not obligated to determine. The issues of excessive delegation and opaqueness/arbitrariness in the NAA’s functioning were the overarching themes in the arguments. And State defended the constitutionality of Section 171 by interpreting it in a manner as if it was the most precise and comprehensive statutory provision. 

Delhi High Court Upholds NAA’s Constitutionality 

The Delhi High Court gave multiple reasons for upholding the constitutionality of NAA. The High Court dutifully cited the principles that presumption of constitutionality guides adjudication of constitutionality of a provision and that in matters of economic laws the legislature has a wide latitude, both principles duly entrenched in Indian jurisprudence via a long line of judicial precedents. Further, the High Court observed that GST heralded a new indirect tax regime in India to reduce the cascading effect of multiple indirect taxes. On these broad and abstract principles there is little to find fault with the High Court’s approach. It is the specifics that make this judgment deficient in reasoning. I highlight some of the deficiencies below.  

To begin with, one of petitioner’s argument was that the key phrases used in Section 171 ‘commensurate’ and ‘profiteering’ are defined in reference to each other, a case of circular reasoning. The High Court invoked the State’s reference to Directive Principles of State Policy, the objective of GST to reduce cascading effect of taxes, and the dictionary meaning of ‘commensurate’ to conclude: 

Section 171 of the Act, 2017 mandates that whatever is saved in tax must be reduced in price. Section 171 of the Act, 2017 incorporates the principle of unjust enrichment. Accordingly, it has a flavor of consumer welfare regulatory measure, as it seeks to achieve the primary objective behind the Goods and Services Tax regime i.e. to overcome the cascading effect of indirect taxes and to reduce the tax burden on the final consumer. (para 100)

Again, what the Delhi High Court says here is correct, but it does not address the petitioner’s simple argument that in absence of precise phrases or clear definitions the provision suffers from arbitrariness as it allows NAA complete discretion to interpret and implement the provision. Also, the constitutionality of a provision cannot be defended by reference to its intended objectives. The fact that Section 171 was enacted in reference to Directive Principles of State Policy or for consumer protection is irrelevant to the argument that it suffers from arbitrariness. The High Court places undue emphasis on the intent of the provision to adjudicate its constitutionality and sidestepped the core issue of the provision lacking sufficient policy guidance.  

The second questionable aspect of the judgment was in the Delhi High Court’s conclusion that Section 171 contains a clear legislative policy and does not delegate essential legislative functions. And the High Court added that not only does Section 171 prescribe a clear legislative policy it also contains all the navigational tools, checks and balances to guide the authority tasked with its workability. Section 171 creates a substantive obligation on taxpayers to not profiteer, but the authority to implement the mandate, NAA, has under the relevant rules been given the power to determine its own procedure, determine the scope of complaints and investigation, determine the methodology to determine profiteering – without being under an obligation to determine it or disclose it – which cannot be reasonably traced to the statutory provision. And a statutory right to appeal against NAA’s order is absent. In such a scenario, the High Court’s interpretation that Section 171 contains sufficient policy guidance, imbibes Section 171 with more substance than it contains. 

Further, Section 171(3) states that the authority, i.e., NAA shall exercise such  powers and discharge such functions as may be prescribed. And under Rule 126, the Central Government empowers NAA to determine the methodology and procedure for determining if the taxpayers are passing on benefits of reduced taxes to consumers. It is indeed difficult to not see that the delegated legislation function assigned to the Central Government was further passed to NAA leading to a situation where NAA framed Rules to determine its own powers and determine the methodology to determine profiteering. In my view, this is a clear case of impermissible delegated legislation where an authority has been entrusted to self-determine scope of its own powers circumscribed by a thinly worded statutory provision. Also, it is worth pointing out that the Methodology that NAA prescribed in exercise of its powers was not a methodology that reliably informed the taxpayers of how the reduced prices are to be calculated and unreasonably suggested that increased costs of compliance for taxpayers are immaterial to determine compliance with Section 171. The Delhi High Court’s observations on this issue are: 

Moreover, as per Rule 126 NAA ‘may determine’ the methodology and not ‘prescribe’ it. The substantive provision i.e. Section 171 of the Act, 2017 itself provides sufficient guidance to NAA to determine the methodology on a case by case basis depending upon peculiar facts of each case and the nature of the industry and its peculiarities. Consequently, so long as the methodology determined by NAA is fair and reasonable, the petitioners cannot raise the objection that the specifics of the methodology adopted are not prescribed. (para 126) 

What is the difference between ‘determining’ and ‘prescribing’? NAA, in its orders has observed that it is not obligated to prescribe a methodology since different fact situations require different approaches. And it is only supposed to determine the methodology as per the facts, an approach which the Delhi High Court endorses in the above paragraph. But, is it justifiable to rely on the said interpretation to conclude that the methodology need not be revealed to the taxpayers?

The above observations of the Delhi High Court where it almost completely agreed with the State’s arguments and in fact NAA’s own defence of its own constitutionality, pretty much sealed the case for the petitioners. The High Court though concluded that all other arguments of the petitioners’ also did not have a persuasive value. For example, the High Court observed NAA’s investigations could be validly extended beyond the scope of original complaint (para 159), time limit to complete investigations were only directory and not mandatory despite use of the word ‘shall’, (para 158 )and that NAA was a fact-finding body and absence of judicial members was not fatal to its constitutionality. (para 146) The last finding collapses on an examination of NAA’s function and High Court’s own interpretation of Section 171 as a provision that creates a substantive obligation on taxpayers. (para 100) Clearly, in implementing Section 171, NAA is adjudicating on rights and obligations of consumers and taxpayers and yet NAA’s functions were interpreted to be confined to mere fact-finding exercise. While the actual fact-finding was undertaken by the investigative arm of the NAA, i.e., DGAP. And if a body like NAA has powers to impose penalties and cancel registrations, do they not impact taxpayer obligations? How is it defensible to accord it a status of mere fact-finding body performing functions of expert determination? 

Finally, while the State and the Delhi High Court were correct in stating that absence of a right of appeal is not fatal to the constitutionality of a body, it needs to be stated that the absence of such a right should have made the High Court more cautious that there are enough checks and balances to protect taxpayer rights at the NAA level. Instead, by upholding the arguments that investigation by DGAP can traverse beyond the subject matter of complaint, the time limit to complete investigation is directory in nature and otherwise misreading the mandate and nature of NAA, the Delhi High Court has granted a wide leeway to the State in matters of anti-profiteering in particular and generally in drafting tax legislations with unfettered delegated legislative powers to the executive.

Conclusion 

I’ve argued previously that NAA adopted self-serving interpretation of Section 171, relied on opaque and arbitrary methodology to adjudicate complaints of profiteering and that its manner of creation was tinged with unconstitutionality. The Delhi High Court has concluded otherwise, though as I’ve highlighted above, its reasoning and interpretive approaches are not beyond reproach. The concession that the petitioners have received from the Delhi High Court is that NAA adopted a flawed methodology in adjudicating complaints of profiteering in real estate projects. The High Court observed that NAA relied on the difference between ratio of ITC and turnover in pre and post-GST periods, but there is no direct co-relation between ITC and turnover. And that varying expenses and nature of construction activity should have been considered by NAA. But, the impact of these observations will only be revealed when specific orders of NAA are challenged on merits. (para 129) Since a bulk of NAA’s orders related to the real estate sector, this is not insignificant, but still does not detract from the High Court’s flawed approach in engaging with the arguments on constitutionality of NAA.            

NCLT Cannot Declare an Assessment Order as Void: Kerala HC

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The Kerala High Court in a recent judgment used strong words against an order of NCLT, Kochi Bench for declaring an assessment order passed under KVAT Act as void ab initio. The High Court observed that NCLT did not have the power to declare an assessment as void ab initio and quashed its order. I describe the case below and state whether there was a need for Kerala High Court to use harsh words against NCLT. 

Before I describe the case, it is important to reiterate, for context, that Section 14, IBC, 2016 imposes a moratorium on initiation of any coercive legal action against the corporate debtor. Section 14(1)(a) empowers the adjudicating authority to declare a moratorium for prohibiting the institution of suits or continuation of suits against the corporate debtor including any judgment, decree, or order in any court of law. While Section 33(5), IBC, 2016 states that where a liquidation order has been passed, no suit or other legal proceeding shall be initiated by or against the corporate debtor except with prior approval of the adjudicating authority.   

Facts 

The petitioner, Deputy Commissioner (Works Contract) approached the Kerala High Court impugning an order of NCLT, Kochi passed on 26.10.2022 under Section 33(5), IBC, 2016. 

The company, the corporate debtor, against whom an assessment order was passed was under the liquidation process under IBC, 2016 and was admitted into the Corporate Insolvency Resolution Process (‘CIRP’) on 25.10.2019. The CIRP effected public announcement on 03.11.2019 and a moratorium was declared under Section 14, IBC, 2016 which was to be effective on 02.12.2021, the day on which liquidation order was passed.

For the year 2015-16, the GST Department found certain discrepancies relating to VAT payments by the corporate debtor. For the year 2015-16, the corporate debtor was issued a notice under Section 25, KVAT. The assessment against the corporate debtor was completed via order dated 25.02.2021 and total VAT liability was determined as 11,76,35,626.70/- On a Form-C dated 04.01.2022 the Department claimed the said tax amount before the resolution professional appointed for the corporate debtor under IBC, 2016. 

Against the Form-C application, the corporate debtor filed an application before NCLT, Kochi under Section 33(5), IBC, 2016 seeking permission to prefer an appeal against the order of assessment dated 25.02.2021. 

While the petitioner had filed an application seeking permission to file an appeal against the order of assessment, NCLT, Kochi declared the assessment order as void ab initio. NCLT stated that the assessment order had been passed in violation of the prohibition contained in Section 14(1)(a), IBC, 2016 and directed that the tax claim be considered independently without considering the assessment order passed on 25.02.2021. Against the NCLT’s order, the State approached the Kerala High Court.  

Kerala High Court Expounds on the Law 

The issue before the Kerala High Court was: whether the NCLT is empowered to declare an assessment order as void ab initio under Section 33(5) of IBC? The straightforward answer is no, and the High Court arrived at the same conclusion, but not before it had a few harsh words to say about NCLT, Kochi. 

The law on the interface of tax claims and IBC has been expounded by various judgments, with the Courts on various occasions clarifying the overriding effect of IBC over all other legislations including tax laws. The Kerala High Court relied on two judgments, VM Deshpande case and the Sundaresh Bhatt case. The latter case was decided in the context of interplay of IBC, 2016 and Customs Act where the Supreme Court had clarified that the custom authorities can only determine the tax, interest, fine or any penalties that are due but cannot enforce their claims during the period of moratorium. This was the ratio of VM Deshpande case too, though decided in the pre-IBC period. 

The Kerala High Court relied on the above two precedents to enunciate that the law was that the tax authorities have the limited power to determine the quantum of tax and make assessments, but not enforce its demands. Accordingly, it rightly held that: 

Thus, after declaring the moratorium, there is an embargo on enforcing the demand, but there is no embargo under Section 14, read with Section 33(5) of the IBC, for determining the quantum of tax and other levies, if any, against the Corporate Debtor. (para 5.3) 

Applying the said dictums to the impugned case meant that during the moratorium the VAT assessments could have been finalized against the corporate debtor, but the said tax assessments could not be enforced. And in enforcing the said tax demands, there was a violation of Section 14, IBC, 2016. In seeking permission of NCLT to appeal against the enforcement of the tax demands, the corporate debtor was trying to enforce the law as laid down by Supreme Court in previous decisions. The NCLT went a few steps ahead and declared the tax assessment as void ab initio and non-est in law. A power that it certainly does not possess under any of the relevant provisions of IBC, 2016. NCLT should have merely provided the corporate debtor a permission to appeal, while not commenting on the assessment order per se. The Kerala High Court correctly quashed NCLT’s order and in doing so termed it as preposterous, untenable, and showing a lack of basic understanding of law. (para 6)

Conclusion 

The Kerala High Court correctly interpreted and applied the relevant precedents to the facts of the case. Equally, it was right in terming the NCLT’s order as untenable in law. The High Court in striking down the NCLT’s order also commented on the quality of persons in NCLT and their competence. I’m sure there are more suitable and appropriate channels to address the quality of personnel in NCLT instead of commenting on their legal aptitude in a judgment. I do not agree with NCLT striking down the assessment order and NCLT should have approached the issue in a more considered manner, but the Kerala High Court’s comments on NCLT personnel in the judgment could have been avoided as well.         

Religious Vows and Income Tax Obligations: Harmony to Clash 

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The Supreme Court is currently seized of a matter which, at its core, involves determining to what extent do the religious beliefs of a person exempt them from withholding tax obligations under the IT Act, 1961. In this article, I will focus on the issues involved and refer to the relevant judgments of the Madras High Court – Single Judge Bench and Division Bench, as well as the judgment of a Single Judge Bench of the Kerala High Court, currently under appeal before a Division Bench. The judgments reveal differing opinions and unravel layers of the central dilemma – should interpretation of tax law accommodate personal religious beliefs, or should tax law be indifferent to religious beliefs, irrespective of the hardship it may cause.    

Background 

The controversy involved nuns, sisters, priests, or fathers who provided their services as teachers in schools. The schools were provided grant-in-aid by the State Government under its grant-in-aid scheme. Christian religious institutions/religious congregations (‘societies’) which controlled the schools and represented the cause of the teachers before the High Court(s) contended that the teachers were bound by Canon law as they taken vows of poverty to the Christ. As a result of their vows, the teachers had suffered a civil death, were incapable of owning property and thus their salaries belonged to the society in question. The teachers were obligated to ‘make over’ their salaries to the societies and did not possess any title over them. And it was the society which accounted for the money in its tax returns and not the teachers. In view of the above, the petitioners contended that the salaries of teachers cannot be subjected to deduction of tax at source as stipulated under IT Act, 1961.  

Before I summarise the arguments adopted by the parties, it is vital to understand the successive Circulars and Instructions issued by CBDT on the issue. I’ve summarised the content of each Circular in a chronological fashion.  

Circular No.5 of 1940, issued on 02.01.1940: Medical fees, examination fees or any other kind of fees received by the missionaries are taxable in the hands of the missionaries themselves, even though they are required by terms of their contracts to make over the fees to the societies. The Circular stated that not only does the accrual happen in favor of the missionaries but there is an actual receipt by them. 

Circular No.1 of 1944, issued on 24.01.1944: Cited the principle of diversion of income and noted that the fees received by missionaries is not their income and clarified that where a missionary employee collects fees in payment of bills due to the institution, the amount collected will income of the institution and not of the employee. No income tax will be collected on fees received by missionaries for services rendered by them which as per their conditions of service they are required to make over to the society. 

Circular F. No. 200/88/75-II (AI), issued on 05.12.1977: Referred to the Circular of 1944 and reiterated that since the fees received by the missionaries is to be made over to the congregation there is an overriding title to the fees which would entitle the missionaries exemption from payment of income tax. 

CBDT Letter, F. No. 385/10/2015-IT (B), issued on 26.02.2016: Observed that the Circular of 1944, which was reiterated in 1977, was only applicable on amounts received as fees as payment of bills due to the institutions and does not cover salaries and pensions. And while Circular of 1977 mentions the word ‘salary’, the operative portion only dealt with fees. 

CBDT Letter, F. No. 385/10/2015-IT (B), issued on 07.04.2016: Reiterated the position in previous letter and noted that salary and pension earned by member of congregation in lieu of services rendered by them in their individual capacity are taxable in the hands of members even if same are made over to the congregation. No exemption from TDS is envisaged under the Circulars and Instructions of the Board. 

The shift in stance on TDS obligations, from 1944 to 2016, is evident from a summary of the above Circulars. The shift though was not caused by any substantive change in the underlying law but facts. From 2015 onwards, the teachers were to be paid salaries in their individual accounts via ECS, while previously the grant-in-aid from the State Government was credited as a lumpsum amount to the account of the societies itself. Prior to 2015, no withholding tax was deducted, primarily because that was the interpretation of the 1977 Circular. However, in 2015, before crediting the salaries to individual accounts of teachers, the Pay and Accounts Officer addressed a communication to the Principal Commissioner of Income Tax (Chennai) as to whether tax is to be deducted from salaries of teachers and received a reply in the affirmative, which the societies alleged was contrary to the Circulars issued until then. Nonetheless, it triggered a chain of events which culminated into CBDT Instructions of 2016 which also affirmed that tax should be deducted and thereafter societies filed writ petitions before the Madras and the Kerala High Court challenging the orders of deduction of tax. 

Diversion of Income vis-a-vis Application of Income 

The Revenue’s stance that religious beliefs do not exempt from withholding tax obligations highlighted the apolitical character of IT Act, 1961. And the Division Bench of the Madras High Court agreed with this argument and premised its interpretation of provisions relating to withholding tax partly on that assumption. (paras 29-30) In my view though, the Revenue’s case hinges on the core issue that the salary of teachers which they are bound to make over to the societies is an application of the teacher’s income and not a diversion of income. The petitioners contended otherwise: that the societies had an overriding title on the teacher’s salaries due to their vow of poverty and making over the salaries amounts to diversion of income and not application of income. 

Application of income, under direct tax law, means a person applies the income or spends it on an avenue of his choosing ‘after’ its receipt. This could mean donation of the entire income to another person, transferring a part or entirety of the income to a dependent based on a previous promise or otherwise parting with the income after receiving it. In such cases, since the income is received by the person and is accrued in their favor, it is taxable in the person’s hands. The subsequent application of income for charitable or other purposes is immaterial to chargeability of income in the hands of the person who receives the income in the first place.  

Diversion of income, fully expressed as ‘diversion of income by an overriding title at source’, implies that the person has diverted their income, by a contractual arrangement or otherwise, to another person and never receives the income. It is important that not only does the person not receive the income, but more crucially the accrual does not happen in favor of the person who diverts their income. Diversion of income can happen in various ways. If a person, as part of an employment or professional contract, dedicates a portion of his income to a charity whereby a charity has a right to receive such money every month, it can be said that the person has diverted that portion of their income and created a charge in favor of the charity. The portion of money earmarked for charity neither accrues in the person’s favor nor does it receive that income. The diversion needs to happen at the source of income to create an overriding title in favor of the other person. But, if the contractual terms are such that the entire income accrues in favor of the person and thereafter a portion of income is diverted towards charity, it will not amount to diversion of income but application of income. 

Courts in India have tried to demarcate the two concepts through various decisions. And while an articulation of the concepts is coherent, their application to various fact situations remains a challenge. Courts have, for example, observed that diversion of income happens where third person becomes entitled to receive the amount before an assessee can lay claim to receive it as its income, but no diversion of income happens when it is passed to a third person after receipt of income even if it may be passed in discharge of an obligation. These broad dictums while understandable need to be applied to situations that are rarely straightforward such as the current case involving nuns and fathers who have taken a vow of poverty.     

Have Teachers Diverted Their Income?  

Based on the above summary exposition of application and diversion of income, it is apposite to examine if the teachers who have taken a vow of poverty diverted their income or were they recipients of income which they applied in favor the societies. From a Canon law perspective since the teachers had suffered a civil death and were no longer capable of owning property, the case is that of diversion of income. And the teachers should not be taxable. And as the petitioners argued, the teachers were merely conduits, and the income was that of the societies. But such an approach tends to completely discount or at least dilutes relevance of the provisions under IT Act, 1961. 

The Division Bench of Madras High Court and the Single Judge Bench judgment of the Kerala High Court disagreed with the above line of argument and gave the IT Act, 1961 more primacy. Both the Courts in their respective judgements observed that the societies did not have a legal right to receive the salaries as they accrued to individual teachers. While the precepts of canon law might require the teachers to part with their salaries, it was held that the said obligation was in the realm of personal law and did not entitle the societies to receive salaries from the State Government. It can be said that from the State Government and Revenue’s standpoint, only teachers were entitled to receive the salaries, but from the standpoint of societies teachers were mere conduits to receive the money and the right to receive the money was of societies. The latter view, of course, is based primarily if not entirely on personal law.  

The single judge bench of the Madras High Court – against which a writ appeal was decided by the Division Bench of the Madras High Court – however, said the above conclusion did not give ‘due regard to personal law’ and the Revenue Department cannot ignore the personal law of the teachers. And by applying the test of distinction between diversion and application of income enunciated by Courts in previous decisions, Single Judge of the Madras High Court held that the correct conclusion is that the teachers only receive the salary on behalf of their societies as they do not partake in any part of their income. And no tax should be deducted at the time of disbursal of their salaries.      

The question then is to what extent, if at all, should income tax accommodate the religious beliefs of the teachers? If the religious belief is to be accommodated, the teachers would have to be considered as fictitious persons – and also in accordance with the long-standing practice of the Income Tax Department as per its pre-2016 Circulars – and only societies would be considered recipients of income via a deeming fiction. This would save the teachers – who do not receive any benefits of portion of their income in reality – from income tax obligations of filing returns and claiming refunds, etc. If the societies are accounting in their income tax returns, it should not be a problem as it has not been since 1944. 

What is the case for not accommodating the religious beliefs? One, there is no express provision in IT Act, 1961 that exempts people from withholding tax obligations on the ground of their religious beliefs. At the same time, I would suggest that accrual, which is one crucial basis to determine chargeability of income, may be a more pertinent lens to view this issue. For example, if the salary accrues to the teachers – due to their services provided on basis of their qualifications, as argued by the Income Tax Department – then it can be said that IT Act, 1961 and its withholding tax obligations applies to them, and the teachers are merely applying their income by making it over to the societies under their personal vows. In the alternative, if the accrual happens in favor of societies, then it is a clear case of diversion of income. But can personal religious vows transfer titles in property? Doubtful. Though if the societies can argue – and I’m not sure they have – that the teachers are bound to transfer salaries to them not just because of their personal vows but also under their contractual obligations with the school/societies, there may be room to suggest that diversion of income happens under contractual terms as well, creating an escape from withholding tax obligations. 

Story of CBDT Circulars 

Apart from the above, a sister issue is that of the validity, content, and scope of Circulars. The Income Tax Department has contended before the Courts that the Circulars that were issued under the IT Act, 1922 and do not represent the legal position under IT Act, 1961. Further, it has been argued the Circulars issued before 2016, only clarify the legal position as regards the fees received by teachers in a fiduciary capacity and not the salaries and pensions. For example, while the Circular of 1977 mentions salaries, the operative part of the Circular only refers to fees. The Division Bench of Madras High Court has opined that the Circulars suffer from vagueness, do not refer to the contemporary position such as the requirement of crediting salaries of teachers in their individual bank accounts such via ECS. Further, the Madras High Court in the same judgment has held that the Circulars can only act as a guide to interpretation and are not binding on Courts. And more importantly, the CBDT does not have the power to grant exemptions when the statutory provisions do not permit such exemptions.  

The Single Judge Bench of the Madras High Court opined that the Principal Commissioner of Chennai could not have issued directions to deduct tax by ignoring the previous valid Circulars. But, the Revenue has a persuasive argument in stating that pre-2016 Circulars only refer to fees and not salaries and pensions. The Single Judge of the Madras High Court questioned the validity of 2016 Instructions on the ground it covered the same subject matter as the previous Circulars. While the Division Bench held that the pre-2016 Circulars did not apply to salaries, but only fees. This, again, is a matter of interpretation. A perusal of the Circulars does suggest that the pre-2016 Circulars clarify tax obligations on fee and refer to salaries incidentally. Even if fee is interpreted to encompass salaries, the more crucial fact in my view is that the manner of crediting salaries has changed. Post-2015, teachers are supposed to be paid salaries via ECS in their individual accounts undeniably making them recipients of the income. This fact was not considered in pre-2015 Circulars necessitating issuance of new directions in 2016. Change in facts can change the interpretation of law. I doubt there is much grouse in that argument.  

Conclusion

I think the ‘correct’ answer in this case depends on various parameters and what is accorded due importance. The Single Judge of the Madras High Court invoked Fundamental Rights relating to religion under Article 25 and 26 to support his conclusion in favor of the teachers, while the Division Bench dismissed their relevance to the issue. Similarly, as highlighted above, if personal law is given primary consideration, then the conclusion favors the teachers, while if a strict interpretation of the withholding tax provisions is followed then as the Division Bench of the Madras High Court observed, there is no exemption based on personal religious beliefs. In my view, a deeper look into accrual and by extension diversion and application of income may provide us an insight as to how to satisfactorily resolve this issue. The Single Judge of Kerala High Court, for example, based its conclusion by reasoning that the salary accrued to the teachers who provided service in their individual capacity and not to the societies. The right to receive income is that of the teachers who entrust their salaries to the societies under a personal vow. (para 16) And, this is a fair conclusion and understanding of the arrangement. In fact, this is what the first Circular of 1940 also infers, but in the context of fees. Last, it is worthwhile to underline that the validity of Circulars and Instructions and the interpretation placed on them may ultimately prove to be crucial in determining the fate of this case.       

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