Rav Singh

Portuguese Civil Code, Income Tax, and Companies Act: Understanding Beneficial Ownership 

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The Bombay High Court, in a recent judgment, had to unravel the interplay of Portuguese Civil Code, IT Act, 1961, and the Companies Act, 1956 – among other issues – to ascertain the tax liability of assessees. While the case involved other issues, I will focus on the beneficial ownership aspect and how the assessees understood it and the High Courts’ response to the same.   

Introduction  

The appellant in the case, along with his two brothers each held around 30-33% of shares in private limited companies which were engaged in the business of construction and hospitality. All the three brothers were married to their spouses in terms of the Portuguese Civil Code (‘Code’) as applicable to the State of Goa. Under the Code, in the absence of any ante nuptial agreement between the spouses, each of them had 50% right to their common estate. The IT Act, 1961 acknowledges the applicability of the Code and to that extent, under Section 5A provides that: 

            Where the husband and wife are governed by the system of community of property (known under the Portuguese Civil Code of 1860 as “Communiao Dos Bens”) in force in the State of Goa and in the Union Territories of Dadra and Nagar Haveli and Daman and Diu, the income of the husband and of the wife under any head of income shall not be assessed as that of such community of property (whether treated as an association of persons or a body of individuals), but such income of the husband and of the wife under each head of income (other than the head “Salaries”) shall be apportioned equally between the husband and the wife and the income so apportioned shall be included separately in the total income of the husband and of the wife respectively, and the remaining provisions of this Act shall apply accordingly.    

For the Assessment Year 2011-12, the appellant filed the return on income on 29.09.2011 under Section 139(1) of the IT Act, 1961, comprising of income under various heads. The return was processed on 27.09.2012. A search was conducted on 30.01.2012 in the premises of one of the companies in which the appellant was a registered shareholder and subsequently was issued a notice requiring filing of their revised returns for the Assessment Years from 2006-07 including those of 2011-12. The appellant replied that the returns filed on 29.09.2011 be treated as the returns in response to the notice. The appellant also submitted detailed explanations and documents. The Assessing Officer rejected explanations of the appellant and added income under Section 2(22)(e) of the IT Act, 1961 and held that the payments made to the appellant in various transactions through the companies was deemed dividend. Similar additions were also made to the incomes of wives of all the three brothers. 

After a series of contrary decisions at the Assessing Officer and Commissioner level, the ITAT held that the amounts were correctly added to the income of appellant against which the latter approached the Bombay High Court. On the issue of beneficial ownership, the question before the High Court was: the appellant who holds 33% of the shares in company can by virtue of being governed by the Code said to be holding only 16.5% shares with his wife being the beneficial owner of the other half? Why was the extent of shareholding – 33% or 16.5% – important? This is because under Section 2(22)(e) of the IT Act, 1961, for a loan or advance made by a private company, to be considered as a deemed dividend, it is important that such payment is made to a person holding a substantial interest, subject to fulfilment of other conditions. And under Section 2(32) of the IT Act, 1961 a ‘person who has a substantial interest in the company’ in relation to a company, means a person who is the beneficial owner of the shares, not being shares entitled to a fixed rate of dividend whether or without a right to participate in profits, carrying not less than 20% of the voting power.  Section 2(22)(e) read with Section 2(32) of the IT Act, 1961 meant that for the purposes of appellant, if his shareholding in the company was adjudged to be 16.5% and not 33%, the deemed dividend provision would not apply to it.       

The appellant’s argument thus was: Under the Code, in a contract of marriage, the ownership and possession of common assets vests in both the spouses during the subsistence of marriage. Where the husband is 33% registered holder of the shares in a company, his wife is the beneficial owner of half (16.5%) of the shares in company. The argument ran into the hurdle of Section 187C, Companies Act, 1956.  

Section 187C, Companies Act, 1956

Section 187C (1), Companies Act, 1956 provides that any person whose name is entered in the register of members of a company but does not hold beneficial interest in the shares shall make a declaration to the company specifying name and particulars of the person who holds the beneficial interest. Sub-section (2) further provides that a person who holds beneficial interest in a share or shares of a company shall make a declaration the company specifying the nature of interest.   

Relying on the mandate of Section 187C(1) and (2), the Revenue argued that under Section 187C of the Companies Act, 1956 the appellant was under an obligation make declaration to the company about who holds beneficial ownership of shares but having failed to do so, now cannot take advantage of the Code to claim beneficial ownership. Further, the Revenue argued that the Code which provides for communion of assets between spouses is not applicable to shares of companies since only the person whose name is in the Register of Shareholders of the company has the voting rights based on shares held by him and that voting right cannot be divided between the two spouses.  

The appellant though contested the Revenue’s argument and stated that Section 187C of Companies Act, 1956 only applied where beneficial shareholding was created through contract and not by virtue of the operation of law, in this case, the Code. The appellant’s view, as per the High Court, would imply that two class of shareholders could be created – those bound by Section 187C, while those exempt from Section 187C since they were governed by the Code. But was this distinct and separate class of shareholders recognized under the Companies Act, 1956? The High Court answered in the negative. 

Examining the relevant provisions of Companies Act, 1956 the High Court correctly concluded that only a person who agrees to Memorandum of Articles of a company, or a person who holds equity capital in the company, and whose name is entered as beneficial owner of shares can claim to be a member of the company. And only a member of the company shall hold voting rights in the company in proportion to the capital owned. No third person can claim to be a member or hold voting rights. The High Court’s conclusion was that Companies Act, 1956 was a complete code in itself and it ‘does not does not envisage a situation where by virtue of a personal law applicable to a shareholder of a company, the spouse of such shareholder could claim voting rights in a poll to pass resolutions or, for that matter, claim a privity of contract to bind herself to the Memorandum of a Company and the Articles of Association of such company.’ (para 57) 

The High Court’s conclusion did not disrupt the position under the Code in that each spouse is entitled to 50% of the assets. However, the High Court was clear in its opinion that the Code not per se or automatically disrupt internal scheme of the Companies Act, 1956.  

Narrow Understanding of Beneficial Ownership? 

The concept of beneficial ownership is acknowledged under all the above-mentioned relevant provisions of the IT Act, 1961 and the Companies Act, 1956. The question is if the concept needs to be understood and interpreted as per the objectives of the provision and statute in question, and whether there is parity in the concepts of both the statutes? The Bombay High Court’s opinion was that the terms ‘beneficial owner of shares’, ‘shareholder’, ‘member’ used in Section 2(22)(e) of IT Act, 1961 only meant registered shareholder or registered beneficial owner whose name is in the register of shareholders. To this extent, it was correct in stating that there was an equivalence in the concepts under both the statutes – IT Act, 1961 and Companies Act, 1956.

However, was the High Court’s opinion, that the wife is not a beneficial owner of shares unless her name is registered a narrow understanding of the concept of beneficial ownership and does it dilute one of the core ideas contained in the Code. Prima facie, yes. But, as the High Court justified, personal law cannot create a relationship between the wife and other members of the company. Such a relation must be and can only be created under the Companies Act or there needs to be an express provision acknowledging the overriding effect of the personal law. The accommodation to the Code is provided in Section 5A of the IT Act, 1961, but a similar and comparable provision is absent in the Companies Act, 1956. In such a scenario, while the concept of beneficial ownership seems to be narrowly interpreted by the Bombay High Court, it shows fidelity to the provisions that governed the concept and issue at hand.

Further, it is worth thinking if the wife was registered as a beneficial owner of 16.5% of shares, if and how the outcome would have differed? The outcome, in my view, would have been in favour of the appellant, but not because of operation of the Code but because of proof of compliance with the Companies Act which would have created evidence of beneficial ownership. Again, the concept of beneficial ownership is acknowledged, but only if the prescribed formalities under the Companies Act are followed. This to be seems a reasonable and defensible approach towards the interplay of the Code and Companies Act.     

Unfamiliar Terrain of Loyalty Points and GST

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Levying GST on atypical forms of consideration is a familiar problem under GST regime. One such problem relates to the levy of GST on vouchers issued by a supplier. While we have a modicum of certainty on the interface of vouchers and GST, on another form of consideration, i.e., loyalty points, applicability of GST remain a source of intrigue. In this article, I elaborate on some of the challenges posed by issuance of loyalty points and the unanswered questions about the levy of GST on their issuance, cancellation, among other aspects. 

Identity of Loyalty Points

The first challenge is accurately identifying loyalty points. It is unclear if loyalty points can be classified as actionable claims, vouchers, or a form of money. One advance ruling relating loyalty points has stated that loyalty points, until they are valid, constitute as actionable claims. However, after their expiry period, they cease to be actionable claims. AAR’s reasoning was that after the expiry date of the loyalty points, the customer can no longer redeem them and loses any right over them. Since the customer loses the right to initiate legal action in relation to their loyalty points after their expiry, they cease to be actionable claims. AAR however, stopped short of identifying the nature of loyalty points after their expiry period. AAAR, in an appealagainst the ruling, took the same view.  

During the hearing before AAR, the Revenue Department commented that loyalty points do not amount to actionable claims but chose in possession. The Department emphasized that actionable claims comprise of two kinds of claims: (a) claim to unsecured debt; and (b) claim to beneficial interest in a movable property. And argued that since the beneficial interest in movable property was in the possession of customers the loyalty points cannot be termed as actionable claims but instead should be characterized as chose in possession. 

It is difficult to buy the distinction between actionable claims and chose in possession articulated by the Revenue Department. Actionable claims rarely cease to be such merely because the beneficial interest in the movable property is in the possession of the customer. Chose in possession tends to be broader concept encompassing a bundle of rights over an object, and the possession of the object is not determinative of its character. Further, the identity of loyalty points also overlaps with the definition of vouchers. Section 2(118), CGST Act, 2017 defines voucher as 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 to be supplied or identities of potential suppliers are indicated on the instrument itself. It is difficult to argue that loyalty points constitute as an ‘instrument’ and can strictly speaking, be considered as vouchers as defined under CGST Act, 2017 even though loyalty points would typically fulfil remaining ingredients enlisted in definition of the voucher. 

While High Courts have termed gift vouchers as actionable claims, money, and vouchers as defined under CGST Act, 2017, it is difficult to state if loyalty points can be satisfactorily included in any one of the three categories even if they are analogous with gift vouchers often issued by suppliers to retain and cultivate loyal customers. The context and facts would require examination to accurately determine the identity of loyalty points as it is possible that they are identified in different categories depending on their nature and purpose of use.

Prima facie, it does seem that loyalty points satisfy the definition of an actionable claim. Though, if loyalty points are used in consideration or part consideration of a supply of goods or services, they can be considered as vouchers provided one adopts a broad view of what constitutes as an ‘instrument’ in the definition of vouchers. Irrespective, the identity of loyalty points under the GST regime remains an open question.    

Taxation of Loyalty Points 

The GST consequences of issuance, use, redemption, and expiration of loyalty points remains an equally open-ended question partially, if not substantially, because the identity of loyalty points is not established. The levy of GST in respect of loyalty points has multiple dimensions: their effect on the value of supply, time of supply, and whether the expiry of loyalty points constitutes an independent supply. The last question was the subject of attention in an advance ruling. 

In the advance ruling, the applicant was responsible for managing loyalty points issued by one of its clients to its customers. The applicant charged GST on the service fee it charged its clients for managing their loyalty point program. The client used to pay the applicant Rs 0.25 per loyalty point as issuance charge. If the customer redeemed the loyalty points, the applicant would Rs 0.25 per loyalty point redeemed by the customer to the client. If the customer did not redeem the loyalty points and/or if the loyalty points expired, the applicant would forfeit and retain the amount equivalent to Rs 0.25 per loyalty point. AAR had to answer the question whether the forfeiture of amounts equivalent to expired loyalty points was consideration for actionable claims and whether it would be subject to GST? As mentioned above, AAR held that loyalty points were actionable claims until they expired but ceased to actionable claims after their expiry. AAAR held the same. The other related question was the issue of consideration. AAR held that the forfeiture of amount equivalent to expired loyalty points constituted as revenue for the applicant was issuance fee for the services it provided to its clients for managing their loyalty point programs. The forfeiture amount was consideration for supply of services to its clients in the normal course of business and was part of their remuneration. The forfeiture of expired loyalty points was termed as a supply, and their value was held part of the value of supply. AAAR similarly took the view that consideration for expired loyalty points had flown to the applicant and was its revenue for managing its loyalty point program.  

The advance ruling mentioned above, dealt with specific facts where the loyalty point program of a supplier was managed by a third party. And the taxability of forfeited amount was the specific issue before the advance ruling authority. However, in case, the loyalty point program is managed in-house by a supplier would some of the answers be different? Perhaps. The answers would depend on the terms and conditions underlying the loyalty point program relating to their issuance, redemption, and expiry. Forfeiture of the loyalty points in case of in-house management would not ordinarily amount to a supply, since a third party would not be involved. Neither would any question of consideration arise in such a scenario. 

In another scenario, what if the value of loyalty points reduces at stipulated dates. For example, after 24 months, each loyalty point, instead of being worth Rs 0.25 would be worth Rs 0.10. Would the difference, i.e., Rs 0.15 be treated as consideration? In case of third party managing the loyalty point program, the reduced value is likely to be forfeited by the third party, making it a supply to the extent of the reduced value. In case of in-house management of loyalty point program, the reduced value is unlikely to invite any GST consequences. But, again these are tentative answers and would require scrutiny depending on the terms and conditions of the loyalty program offered by a supplier.     

Conclusion 

This article is a preliminary attempt to highlight some of the GST implications and issues that may arise from the issuance, redemption, and expiry of loyalty points. The aim is to highlight a couple of issues and how the answers are not – currently – straightforward under the GST laws. A parallel aim of the article was also to highlight that loyalty points while comparable are not completely analogous to gift vouchers issued by suppliers and may require customized answers. Though gift vouchers and loyalty points may also intersect in certain circumstances. And further loyalty point programs also differ – third party managed and in-house – and may invite different interpretations and inevitably varied answers.    

Can Cash be Seized During GST Inspections? 

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Section 67 of the CGST Act, 2017 deals with powers of inspection, search, and seizure of officers and Section 67(2) specifically empowers the officers carrying out an inspection to seize goods and documents. Courts have arrived at divergent interpretations as to whether the power to seize goods and documents includes the power to seize cash – unaccounted or otherwise. Relying on the interpretive principle of ejusdem generis and the objective of GST laws, some Courts have held that power to seize goods includes power to seize cash while some Courts – relying on similar factors – have concluded otherwise. 

Short Profile of Section 67

Section 67, CGST Act, 2017 states that where a proper officer not below the rank of Joint Commissioner has reasons to believe that a taxable person has suppressed any transaction in relation to supply of goods or services, or has claimed ITC more than his entitlement or has engaged in the business of transporting of goods in a manner that has caused or is likely to cause tax evasion, he may authorize any officer of central tax to inspect places of business of such taxable person. Section 67(2) along with the two Provisos states as follows: 

Where the proper officer, not below the rank of Joint Commissioner, either pursuant to an inspection carried out under sub-section (1) or otherwise, has reasons to believe that any goods liable to confiscation or any documents or books or things, which in his opinion shall be useful for or relevant to any proceedings under this Act, are secreted in any place, he may authorise in writing any other officer of central tax to search and seize or may himself search and seize such goods, documents or books or things: 

Provided that where it is not practicable to seize any such goods, the proper officer, or any officer authorised by him, may serve on the owner or the custodian of the goods an order that he shall not remove, part with, or otherwise deal with the goods except with the previous permission of such officer: 

Provided further that the documents or books or things so seized shall be retained by such officer only for so long as may be necessary for their examination and for any inquiry or proceedings under this Act. (emphasis added)

The specific question that Courts have have faced is: whether cash is a ‘thing’ and can be seized by officers while carrying out inspections under Section 67? The text of Section 67 does not provide any definitive answer as it does not mention the word ‘money’ and the only way to include money in the scope of Section 67 is through a process of interpretation. While some Courts have relied on the definition of money, as included in CGST Act, 2017, this interpretive approach has not provided a definitive answer to the scope of Section 67 and the power of officers under the said provision.  

Cash is a ‘Thing’ 

The Madhya Pradesh High Court referred to the definitions of ‘consideration’, ‘business’, ‘money’ among others to hold that the term ‘thing’ used in Section 67 includes money. The High Court’s reasoning was that definitions are the key to unlock the objective of CGST Act, 2017. The High Court though never specifically articulated as to what objective of GST laws was served by allowing officers to seize cash belonging to a taxable person. The High Court further tried to reason that a statute must be interpreted in a manner that suppresses the mischief and advances the remedy. Again, here the High Court did not clearly state the mischief and remedy in question. Is the mischief tax evasion? And if so, is it warranted to rely on inconclusive definitions to interpret a provision which provides invasive powers to tax officers?   

The Kerala High Court akin to the Madhya Pradesh High Court also opined that Section 67(2) allows for seizure of cash including things under certain circumstances. However, the Kerala High Court took a different view of the objective of GST and observed that: 

The power of any authority to seize any ‘thing’ while functioning under the provisions of a taxing statute must be guided and informed in its exercise by the object of the statute concerned. In an investigation aimed at detecting tax evasion under the GST Act, we fail to see how cash can be seized especially when it is the admitted case that the cash did not form part of the stock in trade of the appellant’s business.          

The Kerala High Court added that the intelligence officer’s argument that there was huge amount of idle cash at the petitioner’s premises and it wasn’t deposited in the bank reveals the misgivings that officers have of their powers under GST laws. The High Court added that such arguments were only valid if the officer was attached to the Income Tax Department.

The above two decisions show how two High Courts are at odds as to their understanding of the objective of GST. While the Madhya Pradesh High Court reasoned that seizure of cash would serve the object of GST, the Kerala High Court opined that seizure of cash will not serve the purpose of detecting GST evasion especially if it is not part of stock in trade of the taxable person. Both High Courts are at fault in not specifically articulating the object of GST laws. Invoking the ‘object’ of GST laws in abstract and in general terms is not the best interpretive approach and is in fact erroneous. It is not prudent to assume that GST laws have only one objective. One could perhaps argue that inspection and seizure have one overarching objective, i.e., to ensure collection of the tax due and compliance with statutory provisions. But, surely, that is not the ‘only’ object of GST. To argue or even pre-suppose that the only object of GST is to facilitate maximum tax collection is a reductive view of tax laws.  

Further, it is important to highlight that the Kerala High Court casually concluded that Section 67 allows seizure of things including cash without specifically examining the text of the provision and its scope. The principles of strict interpretation of tax statutes were given a complete bypass by the Kerala High Court in observing that cash can be seized under Section 67.  

Cash is Not a ‘Thing’ 

At the other end of spectrum are two decisions of the Delhi High Court. The first case, also discussed here, relied on three major factors to conclude that cash is not included in the term ‘thing’ used in Section 67. The Delhi High Court observed that while Section 67 uses the term ‘goods’ which was a wide term, the caveat in the provision was that they should be liable for confiscation. Goods should be the subject matter or suspected to be subject matter of evasion of tax. Similarly, documents, books or things can be confiscated if in the opinion of the officer they shall be used or are relevant to any proceedings under the Act. 

The Delhi High Court highlighted the drastic nature of the powers of search and seizure and the need to adopt purposive interpretation. The High Court observed that powers under Section 67 have only been given to aid proceedings under CGST Act, 2017 and cash cannot be seized in exercise of powers under Section 67 on the ground that it represents unaccounted wealth. And that unaccounted wealth is the subject matter of IT Act, 1961. 

In the second case, the Delhi High Court also made similar observations and held that if there is no evidence that cash represents sale proceeds of unaccounted goods it cannot be seized under Section 67 of CGST Act, 2017. And that CGST Act does not permit the coercive action of forcibly taking cash from the premises of another person. 

The Delhi High Court’s approach is founded on sounder reasoning as it not only highlights the drastic and intrusive nature of powers of inspection, but also specifically identifies the purpose of these powers. To aid investigation under CGST Act, 2017 cash can be seized but only if represents the sale of unaccounted goods or a related offence under the statute. Cash cannot be seized merely because it is unaccounted income or wealth, which is the subject matter of IT Act ,1961.  

Way Forward 

The Madhya Pradesh High Court’s reasoning to support its conclusion that ‘thing’ includes ‘money’ lacks potency especially because of the High Court’s ignorance of the dictum that tax laws need to be interpreted strictly. By relying on definitions and other provisions, the High Court interpreted the scope of Section 67 which is not ideal. And unlike the Delhi High Court, the Madhya Pradesh High Court did not acknowledge the drastic nature of inspection and seizure powers and how in trying to suppress the mischief of tax evasion it is empowering tax officers beyond what the law specifically states. And any reliance on purposive interpretation is only defensible if the purpose of the statute and/or provision is clearly articulated and the interpretation is to suit that purpose. Reference to abstract objective of the statute is not helpful and leaves a lot to be desired. On balance, the approach adopted by the Delhi High Court – in both its decisions on the issue – is well-reasoned, pragmatic and hopefully will form the bedrock of jurisprudence in future.  

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. 

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