Constitution and Tax

Bombay High Court Decides a ‘Peculiar Case’: Orders Refund of Tax Paid Under Protest

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The Bombay High Court recently adjudicated a case[1] it termed as ‘peculiar’ and ordered that the Revenue Department should refund the tax paid by petitioner under protest. The High Court invoked the doctrine of unjust enrichment and precedents on taxes paid under a mistake of law to support its conclusion. 

Facts 

The facts of the case are straightforward: the petitioner, The Hongkong and Shanghai Banking Corporation, filed a writ petition regarding an amount of Rs 56,19,84,075/- it deposited with the Revenue Department. The petitioner claimed that the payment was without any authority in law and not a tax payable by the petitioner. The Revenue Department undertook audit of petitioner’s books and accounts from March 2007 to April 2012 and raised certain objections on non-payment of service tax by the petitioner for ‘interchange income’. As a fallout of the objections, despite no showcause notice being issued by the Revenue Department or a demand being raised, the petitioner deposited Rs 56,19,84,075/- as tax under protest. The petitioner’s letter that accompanied the deposit clearly stated that the payment of tax was ‘under protest’ and as a matter of good faith to co-operate with the Revenue Department. The petitioner was categorical in its assertion that it was not liable to pay service on the interchange income and payment of tax was only to buy peace with the Revenue Department. 

After the deposit of the said amount, the Revenue Department never took any steps to ascertain the tax liability of the petitioner as no showcause notice was issued to the petitioner as regards its interchange income regarding which objections were raised during the audit. Since the Revenue Department never took any steps for ascertaining the tax liability of the petitioner, the petitioner filed an application for a refund of the amount citing lack of action by the Revenue Department and arguing that the payment was made under protest and should not be considered as payment of tax regarding interchange income. 

The petitioner argued that the retention of the said amount by the Revenue Department would amount to violation of Article 14 of the Constitution as well as Article 265 of the Constitution, the latter forming the crux of its case. 

The Revenue Department’s reason for rejecting the application for refund was that the matter regarding levy of service tax on interchange fee had been referred to a Supreme Court bench and admissibility of refund can only be considered after the bench pronounces its final verdict. The Supreme Court in Citibank N.A. case[2]had delivered a split verdict on taxability of interchange fee and the matter had been referred to a larger bench which had yet to pronounce its verdict. Citing the pendency of the matter before a larger bench of the Supreme Court, the Revenue Department denied a refund. 

Bombay High Court Decides 

The Bombay High Court ordered a refund of the tax paid under protest by the petitioner. As per the High Court, for the Revenue Department to satisfy requirements of Article 265 of the Constitution, i.e., ‘No tax shall be levied or collected except by authority of law’, it needs to demonstrate that it has power to withhold/appropriate the amount towards tax. However, i was not the case as in the impugned case the amounts were received by the Revenue Department by fortuitous circumstance wherein the petitioner voluntarily deposited the amount. 

The Bombay High Court reasoned that since the payment of tax by the petitioner was under protest, it did not preclude the Revenue Department from taking steps to realise the tax and in the absence of such steps such as issuance of showcause notice, the payments made by the petitioner retained the character of tax under protest and not tax collected under authority of law under Article 265 of the Constitution. (paras 25-27) In the absence of any provisions under Finance Act, 1994 – under which service on interchange income was supposedly due – which authorized the Revenue Department to retain the said amounts, the High Court held that retaining such amounts violated Article 265 of the Constitution. The High Court cited relevant precedents to reiterate that even if the amounts were paid under a mistake of law, the petitioner was allowed to claim refunds. And it further underlined that the refusal to refund the tax paid under protest would amount to unjust enrichment on behalf of the Revenue Department.  

What about the pending case before the Supreme Court? The Bombay High Court held that it was not relevant to the issue of refund more so because no show cause notice was issued for the period in question. (para 30) Also, the High Court endorsed petitioner’s argument that even if a recovery is initiated against the petitioner, it is not the case that the Revenue Department will not be in a position to recover the dues given that the petitioner is a reputed bank with large scale operations in the country. 

The Department’s stubborn refusal to refund the amount paid in the impugned case was curious, if not surprising. The reason that a case on taxability of interchange income is pending before the Supreme Court was flimsy to begin with. Even if the Supreme Court in the pending case eventually decides in favor of the Revenue Department, there was nothing to stop it from recovering the said tax dues from the petitioner as the High Court rightly pointed out. And if the Revenue Department was convinced of the taxability, why was no showcause notice issued in the first place after auditing the petitioner’s books? I guess we will never know the answer to this.    

Conclusion 

The Bombay High Court’s conclusion rested on three important points: first, that the amount paid by the petitioner was not under any law, but under protest and lack of action by the Revenue Department ensured that the payment retained the character of tax under protest; second, that retention of tax under protest would amount to violation of Article 265 of the Constitution since a tax can only be collected under a authority of law and any tax paid under protest or a mistake of law is liable to be refunded; third, the High Court also alluded to the doctrine of unjust enrichment and held that if the Revenue Department does not refund the tax paid under protest it would amount to unjust enrichment, a concept that loosely ties in with the mandate of Article 265, but is articulated separately by Courts.             

[1] The Hongkong and Shanghai Banking Corporation v Union of India 2023:BHC-OS:13826-DB. 

[2] Commissioner of GST and Central Excise v M/s Citibank N.A. Civil Appeal No. 8228 of 2019 dated 09.12.2021. 

Supreme Court Opines on Nature of Section 19 of 101st Constitutional Amendment

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In a recent judgment[1], a Division Bench of the Supreme Court engaged in depth with the scope, meaning, and implication of Section 19 of The Constitution (101st Amendment) Act, 2016 (‘101st Amendment’) which catalysed the introduction of GST. Section 19 was a transitory provision which stated that existing indirect tax laws would be valid for one year or until States amend them to bring them in conformity with the 101stAmendment, whichever was earlier. The Supreme Court opined that Section 19 was transitory in nature and for that one year it was the repository of competence of State legislatures powers to amend the existing/pre-GST indirect tax laws. It held that the said legislative power could not be exercised after the period of one year contemplated under Section 19.  

Facts 

The case involved three batch of appeals that arose from special leave petitions filed in the case. 

First, related to the State of Telangana where the local VAT law was amended after coming into force of the 101st Amendment, i.e., 16.09.2016. State of Telangana amended the VAT law via an ordinance dated 17.06.2017 and thereafter the State legislature enacted a law replacing the ordinance which came into force on 02.12.2017. The amendment to VAT law was challenged and the Telangana High Court struck it down on the ground that State legislature could have exercised the power of amendment under Section 19 of the 101stAmendment only to bring the VAT law in conformity with GST laws. Also, the Ordinance could not have been confirmed since the State was denuded of legislative competence under Section 19 after 01.07.2017. Since GST laws came into force on 01.07.2017, the one year time period under Section 19 expired on the said date.     

Second, in the Gujarat batch of cases Section 84A was introduced in the Gujarat VAT Act, 2003 via an amendment gazette on 06.04.2018 with retrospective effect from 01.04.2006. The aim of introducing the said provision was to enable to the Revenue Department to open assessments which had attained finality. The Gujarat High Court struck down the amendment on the ground of lack of legislative competence on part of State legislature after 01.07.2017 and also on the ground that the amendment was manifestly arbitrary. 

Third, involved amendment to the Maharashtra VAT Act. On 15.04.2017 the amendment to the said act was gazetted and thereafter an explanation was added via an Ordinance w.e.f. 06.03.2019. Thereafter, on 09.07.2019 the Ordinance was replaced by the Amendment Act which inserted various provisions including the said explanation. The amendment was upheld by the Bombay High Court and appeals were filed in the Supreme Court against the judgment. 

Legal Issue and Arguments 

I think, it is best to upfront cite the provision that was the centrepiece of the judgment, i.e., Section 19 of the 101st Amendment which states as follows: 

Notwithstanding anything in this Act, any provision of any law relating to tax on goods or services or on both in force in any State immediately before the commencement of this Act, which is inconsistent with the provisions of the Constitution as amended by this Act shall continue to be in force until amended or repealed by a competent Legislature or other competent authority or until expiration of one year from such commencement, whichever is earlier. (emphasis added)

At first glance, Section 19 reveals three things: first, it is a transitory provision; second, it allowed the States to amend pre-existing sales tax provisions make them consistent with the 101st Amendment; third, pre-existing laws such as VAT would cease to have force after one year of commencement of the provision or when they were amended or repealed, whichever was earlier. The one year was until 01.07.2017 when the GST laws came into force. The Supreme Court had to adjudicate on the nature and extent of legislative power conferred to the State legislatures under Section 19. 

To justify amendments to its local VAT law, the primary argument that the State of Telangana’s counsel made was that the effect of an Ordinance and a law was the same, only their manner of creation differed. And that the difference was only about procedure adopted and not subject matter of both legislative instruments. Thus, when the State legislature approved the Ordinance to amend the VAT law was enacted on 02.12.2017, its terms ‘related back’ to the date when the Ordinance was promulgated, i.e., 16.09.2016. Thus, the State legislature’s power to enact the law was preserved even after 01.07.2017. (para 27)

Counsel for State of Maharashtra, in a similar vein, argued that the material fact was the existence of the legislative power with States and not the manner of its exercise. It was argued that Section 19 preserved the power of States to amend the laws and it was erroneous to state that the power to amend the laws was only confined to bring the existing laws in conformity with the GST laws.    

The respondents led with their primary argument by drawing an analogy with Section 19 of the 101stAmendment with Article 243ZF of the Constitution.[2] They argued that the latter was incorporated in the Constitution – via 74th Constitutional Amendment – solely with the purpose of allowing amendments to existing laws and bring them in conformity with the new provisions of the Constitution. Similarly, they argued that Section 19 was limited in conferring legislative power to States, i.e., to bring existing laws in conformity with the 101st Amendment. The respondents relied on Section 19 not being made part of the Constitution text per se, but that it was only included in the Amendment Act and argued that it should be interpreted restrictively. The respondents further argued that interpreting the term ‘amend’ used in Section 19 to confer a power on States to make a law wider than curative legislation which runs contrary to the revised Constitutional architecture introduced by the 101st Amendment would not be in aid of the said Amendment.  

Supreme Court’s Observations on Section 19 

The Supreme Court, in a well-reasoned and detailed judgment has described the changes introduced by the 101st Amendment, its rationale, and the nature of transitory provisions among other things. In this post, I will elaborate on its three main observations on Section 19 that I think are relevant from the perspective of examining the interface of the Constitution and tax. 

First, one of the issues that the Supreme Court had to engage with was the effect of Section 19 not being included in the Constitution itself unlike, for example, Article 243ZF. And whether Section 19 was only ancillary to the 101st Amendment and thereby required to be interpreted in a narrow fashion. Supreme Court observed that the purpose of Section 19 was to preserve the existing laws and allow the Parliament and States to repeal and amend them. Since the 101st Amendment deleted various legislative entries relating to indirect taxes, the absence of such a provision would have been ‘catastrophic’ and denuded the States and Union of such crucial legislative power. (para 74) Comparing Section 19 with Article 243ZF, the Supreme Court noted that: 

However, the fact remains that those provisions as well as Section 19 were enacted in exercise of the constituent power. Section 19 is not, in this court’s opinion comparable to a mere Parliamentary enactment. There cannot be any gain in saying that Section 19 is not a mere legislative device. It was adopted as part of the 101st Constitutional Amendment Act. Undoubtedly, it was not inserted into the Constitution. Whatever reasons impelled Parliament to keep it outside the body of the Constitution, the fact remains that it was introduced as part of the same Amendment Act which entirely revamped the Constitution. (para 80)

The Supreme Court concluded that Section 19 was a transitory provision with limited life and whether it was part of the Constitution or not was academic, what was crucial was the effect of the provision. Thus, as per the Supreme Court the entire argument that Section 19 should be interpreted in a particular manner because of it being part of the Amendment Act but being included in the Constitution per se was irrelevant. Section 19 was enacted via the same process as other provisions of the Amendment Act and was a result of exercise of constituent power and not legislative power. 

Second, the Supreme Court then opined on the effect of the first observation, i.e., Section 19 was enacted as a result of exercise of constituent power. The Supreme Court noted that the 101st Amendment had brought significant changes to the Constitution in terms legislative powers relating to indirect taxes via deletion of legislative entries and thus the legislative powers of States and the Union ‘had to be directly sourced from the Amendment’ in the interim period. (para 92) As per the Supreme Court, in the hiatus period between coming into force of Section 19 and operationalising Article 246A (under which the States and Parliament exercise legislative powers on GST) legislative power should be traced to Section 19. 

In other words, the Supreme Court said that Section 19 was part of the Constitution since it was enacted through the same process as other provisions of the Constitution Amendment. And that since the 101stAmendment deleted previous sources of powers to levy indirect taxes and introduced new a locus of power under Article 246A, the source of legislative power for the transition period should be traced to Section 19. The ‘hiatus’ as per the Supreme Court was because the GST Council had not immediately recommended principles on the basis of which GST laws could be enacted in exercise of powers under Article 246A. And thus concluded that:

It is, therefore, held that there were no limitations under Section 19 (read together with Article 246A), of the Amendment. That provision constituted the expression of the sovereign legislative power, available to both Parliament and state legislatures, to make necessary changes through amendment to the existing laws. (para 97) 

The legislative power under Section 19, as per the Supreme Court, was only constricted by time, i.e., till 01.07.2017 and not in any other manner as suggested by parties to the case. 

The above is a liberal and expansive interpretation of Section 19 and goes far beyond what the text of the provision says. However, the Supreme Court justified by contextualising it and commenting on the drastic changes brought via the 101st Amendment. In my view, Section 19 only allowed States to amend existing provisions to bring them in conformity with the Constitution or enact new provisions to the same end. Section 19 did not allow States or the Parliament to enact any other provision for any other purpose. The restriction was not ‘only’ of time, but also of the nature and purpose of provisions that could be enacted and amended under Section 19. 

Third, and this is an indirect but proximate point, i.e., the Supreme Court clarified that Section 19 could not be used to clothe a retrospective amendment with validity. In other words, while the VAT Act may have been validly enacted, but once the power of States to enact or amend such laws ceased on 01.07.2017, then the States cannot amend the laws after the said date on the ground that laws can be amended retrospectively to cure a defect. The Supreme Court clarified that what was material was the presence of competence on the date on which amendment to the law was made and not the date when the law was enacted. (para 115)

Conclusion 

Supreme Court’s judgment in the impugned case is a well reasoned judgment that examines in depth the impact and nature of transitory provisions. While the Court may have, in my opinion, interpreted the scope of powers provided to the States more expansively than I think Section 19 provides, the end result nonetheless was that all the amendments to VAT Acts of the three States were held to be void on the ground that the States exercised their legislative powers once Section 19 had ceased to have effect. Telangana’s argument of ‘relating back’ was rejected on the ground that the State legislature did not possess competence on the date it enacted the amendment to approve the Ordinance. Similarly, the Supreme Court rejected the State of Gujarat’s argument that the amendment though effected after 01.07.2017 was retrospective in nature. Amendments by State of Maharashtra met the same fate. 

[1] The State of Telangana V M/S Tirumala Constructions 2023 INSC 942. 

[2] Article 243ZF of the Constitution states that: Notwithstanding anything in this Part, any provision of any law relating to Municipalities in force in a State immediately before the commencement of the Constitution (Seventy-fourth Amendment) Act, 1992, which is inconsistent with the provisions of this Part, shall continue to be in force until amended or repealed by a competent Legislature or other competent authority or until the expiration of one year from such commencement, whichever is earlier:   

Patna High Court Upholds Constitutionality of Section 16(4), CGST Act, 2017

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In a recent judgment[1], the Patna High Court upheld the constitutionality of Section 16(4), Central Goods and Services Tax Act, 2017 (‘CGST Act’) and Bihar Goods and Services Tax Act, 2017. Section 16(4), as it stood then, did not allow Input Tax Credit (‘ITC’) in respect of any invoice or debit note for supply of goods or services after due date of furnishing returns under Section 39 of the said Acts. The petitioners alleged the said condition under Section 16(4) to be violative of Article 14 and 300A of the Constitution. The High Court made detailed observations about right to property and nature of ITC to reject the claim of petitioners. In this post, I examine the High Court’s reasoning and whether it withstands scrutiny.  

Introduction 

The petitioners apart from claiming that Section 16(4) violated Article 14 and 300A, also argued that conditions to claim ITC prescribed in Section 16(4) should be understood as procedural in nature as opposed to the ‘substantive’ conditions under Section 16(1) and Section 16(2). And that the former could not override the latter. The petitioners also alternatively argued that Section 16(4) should be read down to apply only to invoices or debit notes received after end of financial year beyond September of the financial year. 

The writ petition involved several cases clubbed together since their facts were similar. The facts of representative case were that the assessee was denied ITC for the tax period February and March 2019 because of late filing of GSTR-3B return. The officer in question relied on Section 16(4), CGST Act, 2017 to deny petitioner’s ITC claim. Section 16(4) which prescribes eligibility and conditions for claiming input tax credit, as it stood then, stated that: 

A registered person shall not be entitled to take input tax credit in respect of any invoice or debit note for supply of goods or services or both after the due date of furnishing of the return under section 39 for the month of September following the end of financial year to which such invoice or debit note pertains or furnishing of the relevant annual return, whichever is earlier. 

Petitioner’s Arguments 

The petitioner made several arguments, but in this post, I will concentrate on the interface of ITC as vested right and right to property under Article 300A. Petitioner argued that ITC constituted a vested right under Article 300A since it was tax paid at the time of purchase of goods and services and is adjusted against tax liability payable on sale of goods and services. And that Section 16(4) was confiscatory in nature as denial of ITC is implied in confiscation of property in the shape of financial benefit belonging to the registered person. (para 15) The petitioner also tried to make the claim that ITC was an indefeasible right. By characterizing ITC as a vested right of the taxpayer, the petitioner was trying to persuade the Court that its denial would amount to deprivation of property and thus violate the constitutional right to property under Article 300A.  

The State, on the other hand, argued that ITC is not a vested right, but a concession/benefit extended by the State and can only be availed as per the conditions laid down in the statute. It was argued that condition prescribed under Section 16(4) are uniformly applicable to all the taxpayers and there is no question it being discriminatory and violating Article 14 of the Constitution.

The characterization of ITC either as a vested right of the taxpayer or a concession extended by the State is not just a superficial exercise, it would determine the extent and nature of restrictions that the State can impose on taxpayers for claiming ITC and the grounds on which ITC can be denied.  

Patna High Court Decides 

The arguments of the petitioners and the State mentioned above, clearly reveal that the petitioner’s view ITC as a vested right while the State views it as a benefit/concession. The imprecise nature of ITC is an eternally indeterminate issue under VAT/GST laws. And the judicial oscillation on this issue tends to provide to a wider than necessary leeway to the State in prescribing onerous conditions to avail ITC and consequently also to deny ITC claims. In adjudicating the issue, the Patna High Court in the impugned case framed the issue in interesting terms, it stated that the question before it is: whether ITC per se is a vested right, the denial of which under Section 16(4) would amount to infringement of constitutional right under Article 300-A of the Constitution? (para 18) 

The Patna High Court laid emphasis on the phrase ‘deprive of his property’ used in Article 300-A of the Constitution to state that the property in question of the person must be deprived without the sanction of the law for it constitute a violation of the right to property under Article 300-A. Thus, it is important for a successful claim under Article 300-A for the petitioner to prove that they possessed the property in the first place. The High Court first examined the language deployed by Section 16 and concluded that there was no ambiguity in the provision and there was no need to read down the provision, as claimed by petitioners in their alternative arguments. And noting the conditions prescribed under Section 16, for a taxpayer to claim ITC, the High Court concluded that: 

we note here that ITC is not unconditional and a registered person becomes entitled to ITC only if the requisite conditions stipulated therein are fulfilled and the restrictions contemplated under sub-section (2) of Section 16 do not apply. One of the conditions to make a registered person entitled to take ITC is prescribed under sub-section (4) of Section 16. The right of a registered person to take ITC under sub-section (1) of Section 16 of the Act becomes a vested right only if the conditions to take it are fulfilled, free of restrictions prescribed under sub-section (2) thereof. (para 26) (emphasis added)

The highlighted part in the above paragraph indicates that the High Court agreed with the petitioner’s argument that ITC is a vested right, but with the added condition that ITC becomes a vested right only if the statutory conditions are fulfilled. Thus, it is possible to deduce from the above that ITC remains a concession/benefit provided by the State prior to the taxpayer fulfilling the statutory conditions, and transforms into a vested right of the taxpayer on fulfilment of the statutory conditions. 

Having stated the above, the High Court logically also arrived at the conclusion that Section 16(4) did not violate Article 300-A of the Constitution as ITC was not a taxpayer’s vested right before fulfilment of the conditions under Section 16(4). Thus, question of deprivation of property did not arise prior to fulfilment of those conditions. It also referred to select precedents in a cursory manner to reiterate that Section 16(4) does not violate Article 19(1)(g) and Article 14 of the Constitution. Though the High Court in a latter part of the judgment observed that ‘the concession of ITC’ is dependent on various conditions laid under Section 16 of CGST Act, 2017. (para 36) This, on the face of it, contradicts its opinion of ITC being a vested right; though one can argue that the latter observation was in the context of ITC before fulfilment of the statutory conditions. 

Conclusion

The nature of ITC has never been sufficiently scrutinised by Courts to arrive at a determinative finding if it constitutes a concession or a vested right of the taxpayer. Hence, when faced with onerous conditions, taxpayers challenge them on the ground that their vested right is being infringed while the State typically responds by claiming that ITC is a concession; impliedly asserting that it has wide powers to prescribe conditions to avail ITC. Courts have preferred to adjudicate such disputes by limiting their observations to the facts without clearly opining on the nature of ITC. And, to the extent, there are some observations, as in the impugned case, they are rarely built upon by other Courts to build a coherent jurisprudence on the issue. This is a trend that needs to be arrested, else similar disputes on ITC are likely to be decided on an ad hoc basis without creating a conceptually sound jurisprudence under GST.      

[1] Gobinda Construction v Union of India 2023 LiveLaw (Pat) 109. 

Compounding Fee is Not Tax

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In a recent judgment[1], the Delhi High Court clarified that merely because appellants paid a compounding fee after initiation of legal proceedings against them, does not permit the State to retain the said amount if there was no legal provision under which the appellants were obligated to make the payment. The High Court clarified that in order to successfully claim the refund of compounding fee, it was not necessary for the appellants to have stated that it was paid under protest.   

Introduction 

The appellants imported fuel dispensing equipment for use at retail outlets in the country but without obtaining registration under the Legal Metrology Act, 2009. The respondents – Director of Legal Metrology and Others – took the view that appellants did not comply with the statutory requirements under Legal Metrology Act, 2009 and initiated proceedings against the appellants. During proceedings, the appellants paid compounding fee to the respondents. 

On examining the issue as to whether appellants need to obtain registration before importing the equipment, a Single Judge of the Delhi High Court held that the appellant was not liable to register under the Legal Metrology Act, 2009. However, the Judge refused to accept the appellant’s plea for refund of the compounding fee reasoning that the payment was not made under coercion, but voluntarily. The judge observed, that at the time of making payment, the appellants did not communicate that they were making the payment under coercion or under protest. 

Decision 

The Division Bench of the Delhi High Court held that it was unable to sustain the conclusions reached by the Single Judge. As per the Division Bench, once it was clear that the appellants were not liable under the Legal Metrology Act, 2009 it was difficult to accept the proposition that they should be held liable to pay the compounding fee.  

The Division Bench concluded: 

We also deem it pertinent to observe that the respondents being “State” cannot be countenanced to retain monies which are otherwise not payable by the appellants under the provisions of the 2009 Act. When viewed in that light, it is evident that the issue of deposit without demur or protest could not have justified the retention of compounding fee. (para 8)

It is evident that the retention of money by the Metrology Department – termed as State – by the Division Bench by viewed as illegal. The Division Bench was clear in stating that a compounding fee was not in the nature of a tax or duty but a payment made to avoid the rigours of a legal proceeding. Payment of compounding fee should not be understood mean acceptance of violation of the statutory provisions or an acceptance of guilt. 

The Division Bench adopted a comparatively more coherent approach in ordering the refund of the compounding fee. If the action of respondents was held to be not violative of the impugned statute, there was little to no reason for disallowing their request to refund the compounding fee paid to thwart legal proceedings initiated under the said statute. Merely not stating that the compounding fee was paid under protest was not a valid ground to deny the refund of compounding fee, and the Single Judge Bench erred in denying the refund.   

[1] Indian Oil Corporation Ltd v Director of Legal Metrology & Ors 2023 LiveLaw (Del) 654. 

Limits of Deeming Fiction: Intermediaries under GST – II

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Constitutionality of Section 13(8)(b) and Section 8(2), IGST Act, 2017

Introduction

As elaborated in the first of this two-part post, the constitutionality of Section 13(8)(b), IGST Act, 2017 has attracted varied judicial opinions that deploy superficial and sub-par reasoning. Nonetheless, a Division Bench of the Bombay High Court delivered a split verdict on the constitutionality of Section 13(8)(b) and referred the issue to a third judge. Justice G.S. Kulkarni in his opinion[1] has adopted a unique perspective towards the issue and in the process arrived at a novel conclusion, whose implications are not entirely clear. The conclusion of Justice Kulkarni is that Section 13(8)(b) and Section 8(2) of IGST Act, 2017 are legal, valid, and constitutional if their operation is confined in their operation to IGST Act only and same cannot be made applicable for levy of tax on services under Central and Maharashtra GST legislations (‘CGST Act’ and ‘MGST Act’ respectively). I examine the reasoning and approach of Justice Kulkarni in the following paragraphs. Please refer to the first part for an introduction to the issue.    

Arguments

The Revenue justified Section 13(8)(b), IGST Act, 2017 by articulating several reasons. The Revenue argued that the place of service for intermediaries was the location of intermediary under the service tax regime as well and a similar legal position has been adopted under GST. Also, it referred to the fact that value addition in case of services by intermediaries happens at the location of intermediary. The Revenue also stated – in my view the real reason for Section 13(8)(b) – that if the location of intermediary was not made the place of service under the impugned provision, then the transaction would have escaped the tax net. (para 13)

The petitioners relied on Article 246A, 269A and 286 of the Constitution to argue that the impugned provision, i.e., Section 13(8)(b), IGST Act, 2017 was violative of the Constitutional limits. The petitioners, for example, argued that by deploying the deeming fiction under Section 13(8)(b), IGST Act, 2017 the Revenue was trying to convert the actual place of supply which was in foreign territory to the place of supplier and tax it as an intra-State supply. And the use of deeming fiction contravened Articles 246A, 269A and 286. The other arguments of the petitioners can be enlisted as follows: the levy of IGST on export of services is de hors the fundamental principle of GST as a destination-based tax, its violates the restrictions imposed by Article 286 which forbid States from levying a tax on transactions which take place in the course of import and the Parliament cannot authorize States to levy tax on export of services by deeming it to be a local supply, the levy is extra-territorial and violative of Article 245. Further, the petitioners also alleged that the levy via Section 13(8)(b) was arbitrary, discriminatory, and violative of Article 14.    

Decision

Justice Kulkarni noted that there is no dispute that the transaction undertaken by taxpayers constitutes an export of service. He agreed with the petitioners and stated that: 

In my opinion, the contention of the petitioners appears to be correct that the transactions in question of the petitioners are in fact a transactions of export of service, as the recipient of service is the foreign principal. The destination/consumption of the services as provided by the petitioners takes place in a foreign land. This completely satisfies the test of “export of service” as defined under Section 2(6) of the IGST Act, also as there is no contra indication that “factually” it can be regarded as either inter-State or intra-State sale of services.(para 60)

Justice Kulkarni relied on the definition of export of services under Section 2(6), IGST Act, 2017 and observed that all the ingredients of were satisfied in the impugned case. Section 2(6), IGST Act, 2017 defines export of services to mean when: (i) the supplier of service is located in India; (ii) the recipient of service is located outside India; (iii) the place of supply of service is outside India; (iv) the payment for such service has been received by the supplier of service in convertible foreign exchange; and (v) the supplier of service and the recipient of service are not merely establishments of a distinct person in accordance with Explanation 1 in section 8. Strictly speaking, the third ingredient, i.e., place of supply of service is not satisfied in the impugned case by virtue of Section 13(8)(b), IGST Act, 2017. However, since that was the centrepiece of the petitioner’s case, accepting it on face value would have prevented engagement with the petitioner’s argument.   

Justice Kulkarni stated that the contention of petitioners is that Section 13(8)(b), IGST Act, 2017 is being read into the Central and State GST legislations, i.e., CGST Act and MGST Act to tax export of services indirectly by treating them as a local supply. He framed the issued as: provisions of IGST Act were being imported into CGST Act and MGST Acts. The framing of the issuing as interplay of two distinct legislations rather than as an issue of legislative competence is crucial. By treating the issue of deeming fiction under Section 13(8)(b), IGST Act, 2017 he was able to address the petitioner’s grievance and yet managed to not situate it completely within the Constitutional context. Thus, Justice Kulkarni engaged with inter-connectedness of various GST legislations as the central issue making the petitioner’s argument of the Parliament’s competence to enact the impugned provision as an allied issue.   

Once Justice Kulkarni framed the issue as discussed above, he elaborated on the different spheres of CGST Act, 2017, IGST Act, 2017 and various State GST legislations. He agreed with the petitioner’s argument that the deeming fiction incorporated in Section 13(8)(b), IGST Act, 2017 would amount to double taxation and linking of two separate transactions. He observed that the commission is subsumed in the transaction that the foreign principal undertakes with Indian importer. And that the transaction between Indian intermediary and foreign principal cannot be understood be part of the transaction foreign principal and Indian importer. Interlinking of the two independent transactions would be contrary to the destination-based character of GST. He noted that if Section 13(8)(b), IGST Act, 2017 would be applied to CGST and MGST Acts, it would ‘in my opinion, it would lead not only to a consequence of double taxation but also to an implausible and illogical effect, in recognizing two independent transactions to be one transaction for the purpose of levy of CGST and MGST as intra-State trade and commerce.’ (para 79)

Developing on the issue of distinct but inter-relatedness of the two transactions and legislations, Justice Kulkarni highlighted that there was a tension in IGST Act, 2017 itself. He specifically cited Section 7(5), IGST Act, 2017 which provides that if supplier is located in India and place of supply is outside India then such supply shall be treated as in the course of inter-State trade or commerce. He observed that there is a dichotomy since on one hand the petitioner’s transaction of export of services is treated as inter-State under Section 7(5) while it is treated as intra-State under Section 13(8(b). The aforesaid comparison and ‘dichotomy’ is not a conclusive reason to not accept the deeming fiction incorporated under Section 13(8(b) since a legislation can incorporate a rule and its exception. Justice Kulkarni was however convinced that operation of both provisions would lead to absurdity and uncertainty in the operation of IGST Act, 2017. (para 82)

Based on the above reasoning Justice Kulkarni concluded that inter-State transactions should be confined to IGST Act and intra-State transactions only to CGST Act and MGST Act. He observed: 

Necessarily transactions which are intra-State transactions and those which are inter- State transactions (trade or commerce) are required to be compartmentalized, so as to be recognized under the separate regimes and without creation of any fictional incongruity in regard to the regimes, they need to be taxed, in the given facts and circumstances. It will be too harsh and not fair to the assessees to suffer any uncertainty in regard to the regimes the assessee’s would be taxed. Such uncertainty is neither conducive to trade or commerce nor of any real benefit to the interest of the revenue. (para 83) 

However, Justice Kulkarni did not hold Section 13(8)(b) and Section 8(2), IGST Act, 2017 to be unconstitutional. Relying on a spate of precedents he observed that if a provision could be read down and made workable to further the intent of legislation, Courts should adopt that path instead of striking down a provision as ultra-vires. And in his opinon the impugned provision could be made workable and reflect legislative intent if its operation was confined solely to IGST Act, 2017 and was not imported into CGST and MGST Act. (paras 84 and 89)   

Conclusion

A straightforward and pithy conclusion of Justice Kulkarni’s opinion is that Section 13(8)(b) and Section 8(2), IGST Act, 2017 is not unconstitutional but its operation has been confined to provisions of IGST Act only and cannot be made applicable to tax on services under CGST and MGST Acts. What does this mean? One immediate implication is that Section 13(8)(b) of IGST Act cannot be used to levy GST on intermediary services provided to a foreign principal by treating their export of services as a local/intra-State supply. This also means that such intermediary services cannot be subjected to IGST since exports are ordinarily speaking, not taxed under the destination-based principle of GST. And Justice Kulkarni has noted expressly that the petitioner’s intermediary services amount to export of services. Any further implications are likely to be revealed in due time as and when the CBIC issues some communication from its end. 

It is important to note that the exclusive domains and compartmentalization that Justice Kulkarni refers to is an appropriate approach to understand the multiple GST legislations, their operation and their respective spheres of operation. Justice Kulkarni through his judgment has brought home the fact that while the entire legislative matrix of GST operates on same fundamental principles, e.g., destination-based tax; they intend to levy tax on different transactions. IGST Act is applicable to inter-State transactions while CGST Act and State GST Acts are applicable on intra-State transactions. Going forward, it would be interesting to watch if the strict compartmentalization advocated by Justice Kulkarni would admit of some exceptions and the circumstances when the dilution of such compartmentalization may be allowed.   

Finally, it is worth noting that the opinion of Justice Kulkarni is a satisfactory resolution to the taxation of intermediary services and their treatment as intra-State supplies. However, given the way Justice Kulkarni chose to frame the issue some of the Constitutional questions raised by the petitioners remain unanswered or unsatisfactorily resolved. For example, we are unsure of the applicability of Articles 249A, 269A, and 286 to GST legislations and how the three vital Constitutional provisions interact with each other. Neither do we have a clear view as to the aforesaid Constitutional provisions constrain the Parliament or otherwise the scope of their influence on GST laws.     

[1] Dharmendra M. Jani v Union of India 2023 SCC OnLine Bom 852. 

Limits of Deeming Fiction: Intermediaries under GST-I

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Constitutionality of Section 13(8)(b), IGST Act, 2017

Introduction

Constitutionality of Section 13 (8)(b), IGST Act has attracted the attention of different Courts. The reason for suspect constitutionality of Section 13 (8)(b), IGST Act is that incorporates a deeming fiction whereby the place of supply for services by an intermediary is in India, i.e., place of service provider instead of the place of recipient. The petitioner’s case was that Section13(8)(b), IGST Act departs from the destination-based character of GST, violates Fundamental Rights under Art 14 and Art 19(1)(g) of the Constitution, and is beyond the Parliament’s competence. There are multiple and varied judicial opinions on the issue and I will explore them in a two-part post. In the first part of this post, I will focus on the judgment pronounced by the Gujarat High Court and by a 2-Judge Bench of the Bombay High Court, both of which leave a lot to be desired. I argue that both decisions engage with the underlying issue superficially and adopt less than adequate reasoning to support their conclusions.    

The Gujarat High Court Upholds GST on Intermediaries

In Material Recycling Association of India case[1], petitioners challenged the constitutional validity of Section 13 (8)(b), IGST Act, 2017. Petitioners were intermediaries providing services to their clients located outside India and earning in foreign convertible currency. As per Section 13 (8)(b), IGST Act, 2017 if a supplier provides intermediary service to a person situated outside India, place of supply of services is deemed to be where the supplier is located. This deeming fiction thereby treats such a transaction as liable to GST. The petitioner challenged the provision as ultra vires of Art 265, 286, Art 14, and Art 19 of the Constitution. Petitioner’s various arguments were underpinned by the central idea that their services constituted as export of services. And export of services or goods could not be subjected to GST since it was a destination-based tax whereunder exports were zero-rated. Further, since the supply of services took place outside India the Parliament lacked competence to enact such a provision.

The Gujarat High Court’s analysis is pithy, and essentially gives a free pass to the legislature by stating that the petitioner’s services could not be considered as an export of services ‘in order to levy CGST and SGST’ and that:

            … it would not qualify to be export of services, more particularly when the legislature has thought it fit to consider the place of supply of services as place of person who provides such service in India. (para 66)

It then curiously did not even agree with the petitioner that the provision in question was a deeming provision and instead upheld the constitutionality of the provision by relying on the fact that a similar situation existed in the pre-GST regime and noted: 

            Therefore, this being a consistent stand of the respondents to tax the service provided by intermediary in India, the same cannot be treated as “export of services” under the IGST Act, 2017 and therefore, rightly included in Section 13(8)(b) of the IGST Act to consider the location of supplier of service as place of supply so as to attract CGST and SGST. (para 67)

Both reasons collapse under the burden of scrutiny. First, let’s decode ‘legislature’s wisdom’. As per the Gujarat High Court, the legislature ‘thought it fit’ to include various transactions in the scope of GST to maximize revenue collection. Legislature enacting provisions to increase revenue collection in no way precludes Courts from examining if the provisions under challenge transgress the Constitution. In fact, one would argue that the primary function of a constitutional Court is to examine if the legislature is enacting provisions within the constitutional limits. For example, in this case, it was incumbent on the Gujarat High Court to examine if the impugned provision satisfied the requirements of Art 286 and/or Art 269A of the Constitution, and whether Art 14 and Art 19(1)(g) were not violated; but the judgment is completely bereft of any such analysis. 

The second reason proffered by the Gujarat High Court was that a similar legal position prevailed in the pre-GST regime. To conclude that a similar provision existed in the pre-GST regime is evidence of the constitutionality of a provision enacted under the IGST Act, 2017 is an unwarranted and unreasonable statement especially when the High Court could not cite any precedent that squarely covered the issue. The Gujarat High Court’s reliance on the fact that similar provision existed in service tax regime to conclude that the Revenue Department has a ‘consistent stand’ and creates a presumption of constitutionality in favour of the provision is a dereliction of duty by a constitutional Court. And, even if there was a judicial decision that upheld the constitutionality of the pre-GST provision, it was incumbent on the Gujarat High Court to examine if the decision remained valid after the constitutional changes that accompanied GST. Nonetheless, the Gujarat High Court’s decision did not conclusively settle this matter as a similar matter was argued before a Division Bench of the Bombay High Court.       

Division Bench of The Bombay High Court Issues a Split Verdict 

The Bombay High Court in Dharmendra M. Jani case[2] decided a similar petition almost a year after the Gujarat High Court’s decision in Material Recycling Association of India case, but it ended in a stalemate with the Division Bench rendering a split decision.  

Justice Ujjal Bhuyan, held that Section 13 (8)(b), IGST Act, 2017 was unconstitutional and rested his conclusion on three observations. First, he examined the aforesaid provision on the touchstone of Art 286 of the Constitution and noted that the supply of service by an intermediary was outside Maharashtra and India. As per him, Section 13 (8)(b), IGST Act, 2017 had created a deeming fiction treating the export of service by an intermediary as an intra-State supply and it was definitely ‘an artificial device created to overcome a constitutional embargo.’ (para 49) Second, he observed that creating a deeming provision such as Section 13(8)(b) where the location of the recipient of service provided by an intermediary though outside India has been treated in India ‘runs contrary to the scheme of the CGST Act as well as the IGST Act besides being beyond the charging sections of both the Acts.’ (para 54) His third reason referred to the transaction’s lack of nexus with India and he concluded that: 

            … section 13(8)(b) of the IGST Act not only falls foul of the overall scheme of the CGST Act and the IGST Act but also offends Articles 245, 246A, 269A and 286(1)(b) of the Constitution. The extra-territorial effect given by way of section 13(8)(b) of the IGST Act has no real connection or nexus with the taxing regime in India introduced by the GST system. (para 56)   

While Justice Bhuyan’s opinion was correct in identifying the lack of nexus and that the provision undermined GST’s fundamental principle of destination-based consumption tax, he failed to clearly articulate as to ‘how’ Section13(8)(b), IGST Act, 2017 contravened Art 286 of Constitution. Art 286(1) prevents the State from levying GST on a supply that takes place outside the State or a supply that takes place in the course of import of goods or services into India’s territory or their export out of India’s territory. While Art 286(2) empowers the Parliament to determine principles for determining when a supply of goods or services takes place in any of the two ways mentioned in Art 286(1). It is unclear in Justice Bhuyan’s opinion as to which aspect of Art 286 does Section 13 (8)(b), IGST Act, 2017 specifically contravene and what is the constitutional embargo that the legislature is trying to circumvent. 

At the same time, Justice Bhuyan’s opinion was notable for understanding that while the source of legislative power regarding the inter-State supply of goods or services could be traced to Art 246A and Art 269A of the Constitution, there were constitutional restraints on such power, such as Art 286 of Constitution, and the impugned provision needed to be examined on those touchstones. More importantly, unlike the Gujarat High Court, he did not accept the argument that the existence of a similar provision under the service tax regime precluded a challenge to Section 13 (8)(b), IGST Act, 2017. He instead stated that the validity of Section 13 (8)(b) read with Section 8 of the IGST Act, 2017 had to be examined on the touchstone of relevant constitutional provisions and not by relying on previous legal provisions. Though he fell short of clearly specifying the nature and extent of constitutional transgression.  

Justice Abhay Ahuja in his separate opinion upheld the constitutionality of Section 13 (8)(b), IGST Act, 2017. He gave a ringing endorsement to the Gujarat High Court’s decision in Material Recycling Association of Indiacase, though he added his reasons, which were equally if not less convincing. I will only briefly mention his reasons since his engagement with the petitioner’s argument is almost cavalier. 

Justice Abhay Ahuja pithily observed that Section 13 (8)(b), IGST Act, 2017 was not contrary to the destination-based principle of GST. He observed that since under GST taxation is on supply by intermediaries and the same was characterized as an inter-State supply, there was no conflict thereby completely missing the thrust of the petitioner’s argument. He also incorrectly stated that the definition of export of services being a general provision would be inapplicable since there was a specific provision defining intermediary. Again, not realizing that the two provisions operated independently and performed different functions. 

Justice Ahuja’s examination of the constitutional dimension is worth discussing in more detail. He began by interpreting the scope of Parliament’s power under Art 269A and Art 286 of the Constitution too widely. He noted that while imports had been deemed to be inter-State trade or commerce under IGST Act, 2017, Art 269A of the Constitution did not take away the power of the Parliament to stipulate ‘any other supply’ to be a supply in the course of inter-State trade or commerce. (para 103) Art 269A(5) specifically provides that:

            Parliament may, by law, formulate the principles for determining the place of supply, and when a supply of goods or of services, or both takes place in the course of inter-State trade or commerce.   

Clearly, Art 269A (5) of the Constitution empowers the Parliament to determine the situs/place of supply for inter-State trade or commerce. Thus, when Justice Ahuja says that Art 269A does not take away power to include any supply as inter-State trade or commerce, it should have been preceded by an examination if the Parliament by exercising its power under Art 269A(5) – to enact Section13(8)(b), IGST Act, 2017 – has acted within the scope of its power and has adhered to the limitations imposed by Art 286 of Constitution. Instead, he held that the ‘whole purpose’ of Art 286(2) of the Constitution was to empower Parliament to determine the situs of supply and since Section13(8)(b), IGST Act, 2017 specifically does that it could not be said to contravene Art 286 of Constitution. His understanding of the nature and purpose of Art 286(2) is partly wrong. And his conclusion about the constitutionality of Section 13 (8)(b), IGST Act, 2017 lacks any examination of the Parliament’s powers under Art 269A read with Art 286 of the Constitution. 

The reasoning adopted by both the Gujarat and the Bombay High Court only contributes to greater uncertainty on GST’s applicability to intermediaries. Further, we have no clarity on the role of Art 286 in the GST regime, no clear articulation on the interplay of Art 246A and Art 269A and a lack of appreciation as to whether and to what extent GST’s identity as a destination-based tax is supposed to constrain Parliament’s legislative power. Are no deviations allowed from the destination-based principle? If they are, on what grounds and to what extent?

Finally, both the Gujarat High Court and Justice Abhay Ahuja of the Bombay High Court endorsed the deeming fiction contained in Section13(8)(b), IGST Act, 2017 by stating that it was essential to bring such intermediary services within the scope of GST to raise revenue. Adopting a revenue-maximising approach is the prerogative of the legislature; but, from the standpoint of Courts, it is crucial that the provision in question is constitutional. The fact that the legislature is better placed to frame a tax policy cannot be cited as a reason to enact provisions that are unconstitutional. We need a more robust examination of the tax dimensions of the Constitution and not a judicial approach that uncritically endorses the view that the legislature deserves a wide leeway in enacting tax laws. Such an approach has a little analytical basis, presumes that the legislature is adequately examining each law minutely and certainly does not warrant giving short shrift to arguments based on constitutional law. 

[1] Material Recycling Association of India v Union of India & Others 2020-VIL-341-GUJ. 

[2] Dharmendra M. Jani v Union of India 2021 SCC OnLine Bom 839. 

Patna High Court Prevents Levy of Entertainment Tax Citing 101st Constitutional Amendment

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A Division Bench of the Patna High Court on 18 May 2023 pronounced a judgment that inter alia required it to examine the interaction of Bihar Entertainment Tax Act, 1948 (Act of 1948) with the 101st Constitutional Amendment Act, 2016 (‘101st Amendment’). While the case involved both, statutory and constitutional issues relating to the scope and nature of entertainment tax, in this post I will focus on the Constitutional aspect of the case. More specifically, nature and scope of power of States to levy entertainment tax after the 101stAmendment.  

Introduction 

The petitioner was a Multi System Operator (‘MCO’) who challenged its tax liability under the Act of 1948. State of Bihar argued that the MCO was liable to pay entertainment tax for transmitting programs it received through satellite. The MCO argued that the tax liability was that of local cable operators who broadcasted those signals to the subscribers and were responsible were providing connection to the subscribers, latter being the taxable event under the Act of 1948. One of the petitioner’s grounds of challenge was the State of Bihar’s lack of competence to levy entertainment tax after the 101st Amendment. There were two prongs to the petitioner’s argument: first, Entry 62 in List II has been amended by the 101st Amendment denuding State the power to levy entertainment tax. Pre and post amendment versions of Entry 62 in List II are respectively as follows: 

Taxes on luxuries, including taxes on entertainments, amusements, betting and gambling. 

Taxes on entertainments and amusements to the extent levied and collected by a Panchayat or a Municipality or a Regional Council or a District Council. 

As per the petitioner the field of legislation, i.e., entertainment tax, was no longer available to a State in the form it was available before the 101st Amendment. Entry 62 in List II has been substituted and only permits levy and collection by local bodies. Consequently, after the 101st Amendment, State of Bihar cannot levy and collect entertainment tax through Commercial Tax Officers as provided in the Act of 1948 and the relevant Rules. 

The second prong of the petitioner’s argument rested on Section 19 of the 101st Amendment which states as follows:

Notwithstanding anything in this Act, any provision of any law relating to tax on goods or services or on both in force in any State immediately before the commencement of this Act, which is inconsistent with the provisions of the Constitution as amended by this Act shall continue to be in force until amended or repealed by a competent Legislature or other competent authority or until expiration of one year from such commencement, whichever is earlier. (emphasis added) 

The petitioner urged that the Act of 1948 cannot justify levy of entertainment tax after the 101st Amendment and one can agree that is a reasonable conclusion since Section 19 only saves ‘law relating to tax on goods or services or on both’. But the petitioner went a step ahead and argued that there is no justification for levy and collection of entertainment tax for the period prior to the 101st Amendment since the power for levy and collection stands extinguished by the substitution of Entry 62 in List II. Now courts have recognized that the effect of substitution is that it repeals and introduces a new law, but the doctrine of ‘substitution effect’ has not yet been fully tested and applied regarding legislative entries in the Constitution. Neither is there complete jurisprudential clarity if the effect of substitution is retrospective in nature. (paras 7-9) In my opinion, the petitioner in making the latter argument was making a novel claim in the constitutional context.  

The State of Bihar, on the other hand, tried to justify its power to levy and collect entertainment tax despite the 101st Amendment amending Entry 62. To begin with, it stated that the 101st Amendment introduced a new clause, i.e., Article 366(26A) which defined ‘services’ as anything other than goods. The State adopted an unusually wide and non-contextual interpretation of ‘services’ to argue that every tax other than on goods would be covered by Section 19 of the 101st Amendment including entertainment tax. The State further referred to Sections 173 and 174 of the Bihar Goods and Services Tax Act, 2017 and claimed that while these provisions repealed the Act of 1948, recovery of arrears of tax was allowed as if the Act of 1948 was not repealed. The State made an alternative plea that the levy and collection of entertainment tax before the 101stAmendment certainly cannot be challenged. The State argued that the repeal and saving clause of Bihar Goods and Services Tax Act, 2017 not only preserved pre-existing tax liability, but also saved the levy and collection of tax prior to the 101st Amendment.       

101st Constitution Amendment Narrows State’s Power to Levy Entertainment Tax  

Patna High Court agreed with the petitioner’s arguments and made some interesting though not fully reasoned observations.  

To begin with, the High Court did not agree with the State’s argument that the definition of services encompassed entertainment tax. The High Court rightly reasoned that if the term ‘services’ was intended to subsume every tax there was no reason to retain Entry 62 and it could have been deleted like some other entries such as Entry 52 relating to entry taxes which was deleted via the 101st Amendment. Entertainment tax survived the 101st Amendment albeit in a modified form presumably with an intent to keep it as a separate levy instead of subsuming it under GST. In stating so, the High Court offered a more credible interpretation as compared to the State’s expansive understanding of the term ‘services’ under Article 366. (paras 32 and 33)

As regards the impact and effect of Section 19, the High Court stated that inconsistent provisions in State legislations could be continued for one year or till their repeal/amendment by respective State legislatures, whichever was earlier. However, the Act of 1948 while validly legislated under Entry 62, as it existed then, could not be sustained after the 101st Amendment because of the changes made to Entry 62. This conclusion also is a right understanding and naturally flows from the High Court’s understanding of the scope of Section 19, i.e., it did not extend to entertainment tax.    

However, as regards the petitioner’s argument that entertainment tax cannot be collected even for the period before the 101st Amendment, the High Court concluded that: 

The tax for the period prior to the amendment, though levied on the taxable event occurring, cannot also be collected since there is no transition provision available under the 101st Amendment making such collection of entertainment tax permissible for one year or by way of a repeal; by an enactment, consistent with the amendment, with a saving clause for continuance of the levy and collection under the old Act as it was never repealed. (para 40) (emphasis added)  

The above observation does not fully add up. Why would a transition provision be necessary to collect tax for a taxable event that occurred before the 101st Amendment? If at the time of occurrence of the taxable event, State of Bihar had the authority to levy and collect entertainment tax, it should be allowed to recover the same even after the 101st Amendment. Why should the power to recover pre-amendment tax liabilities cease abruptly if the transition provision does not encompass entertainment tax? Transition provisions, such as Section 19, aim to smoothen transition and allow States time to impose taxes under pre-existing laws such as VAT and/or amend the stated laws in consonance with the new regime, in this case GST. The High Court was right in observing that Section 19 excluded entertainment tax and thereby did not allow States to levy and collect entertainment tax for taxable event under the Act of 1948 occurring after the 1.07.2017, the date of 101st Amendment. However, there is little to justify that Section 19 also implies that taxable events occurred and tax liabilities incurred by taxpayers before that date should not be satisfied by taxpayers.

The High Court to fortify its reasoning needed to engage more deeply with the argument that Entry 62 in List II has been substituted and its resultant effect. A prima facie conclusion is that Entry 62 has been amended/modified, retaining power regarding entertainment tax with the State subject to it being levied and collected at the local level. However, given the transformative changes introduced in indirect tax regime – labelled under the umbrella heading of GST regime – by the 101st Amendment it would not be out of context to suggest that Entry 62 is substituted. There are arguments that can be made from both sides, but the judgment provides little insight about the scope of arguments and neither does it engage with this crucial issue in a meaningful manner. In my view, States are allowed to recover arrears of tax relating to the period before the 101st Amendment and a typical savings clause such as in Sections 173 and 174 of the Bihar Goods and Services Act, 2017 is usually beyond reproach. The onus is on the petitioners to prove that the tax arrears cannot be collected. In this case, the High Court thought that the petitioners have discharged the burden, but its reasoning didn’t seem sufficiently persuasive.     

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

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

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

Introduction

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

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

Using Legislative History as an Aid to Constitutional Interpretation

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

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

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

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

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

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

Bifurcating Recommendations into Two Categories 

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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