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. 

Budgetary Support Scheme: High Court Interprets Eligibility Criteria Strictly

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Budgetary Support Scheme (‘BSS’) was introduced by the Union of India (‘Union’) for taxpayers to smoothen their transition to GST. Taxpayers who received concessions or exemptions under the pre-GST indirect tax regime would cease to receive the said concessions or exemptions due to subsumption of various indirect levies by GST. To ameliorate cessation of tax benefits due to introduction of GST, the State introduced BSS under which taxpayers who received exemptions under pre-GST indirect levies were eligible to receive partial refund of GST if they fulfilled the eligibility conditions. The High Court of Jammu & Kashmir and Ladakh pronounced a judgment[1] on 23 May 2023, interpreting the eligibility condition for BSS strictly and rejecting taxpayer’s claim to receive refund of GST. 

Taxpayers Claim 

The petitioner/taxpayer in the impugned case received exemption from payment of excise duty under a Notification issued by the Union under Central Excise Act, 1944. The benefit of excise duty exemption extended to goods described in the Table falling within different Chapters of the Notification. In the impugned case the Chapter 38 was the relevant Chapter. The petitioner claimed it was eligible to claim excise duty exemption under the broad HSN Code 3808 under Chapter 38. The petitioner was originally entitled to claim the exemption until October 2026, but due to the introduction of GST – and subsumption of excise duty – in July 2017, the petitioner had to apply for budgetary support under BSS. 

The petitioner claimed budgetary support by arguing that the exemption Notification covered all goods under the broad HSN Code 3808 and did not distinguish between various sub-headings under Chapter 38. While the Union resisted the claim by arguing that the exemption Notification covered specific goods and not all goodsunder the HSN Code 3808. The Union argued that the goods manufactured by the petitioner when it availed benefit under the exemption Notification were different than those manufactured after commencement of GST. As per the Union, the petitioner was only eligible for budgetary support if the goods manufactured after introduction of GST co-related to the same sub-headings as goods manufactured prior to GST.  While as per the petitioner, if the goods manufactured were covered under the umbrella code of 3808, they were eligible for budgetary support and the exact sub-heading was immaterial.

Since the goods manufactured by the petitioner before GST were different from those manufactured after introduction of GST, it adopted a broader interpretation of the exemption Notification and BSS eligibility conditions. The Union, on the other hand, adopted a comparatively more restrictive interpretation.  

High Court Rejects Taxpayers Claim 

The High Court stated that the appropriate manner to determine if the taxpayer was eligible to claim budgetary support was to examine the conditions specified for eligibility. One of the conditions, relevant for the purposes of the case, was that the taxpayer must be manufacturing specified goods. And specified goods were defined in BSS as goods which were being manufactured and cleared by the eligible unit by availing the benefit of excise duty exemption upto 1.07.2017. 

The High Court read the eligibility conditions of BSS with the definition of specified goods to mean that a taxpayer to claim the budgetary support must: be manufacturing goods covered under the HSN Code 3808, must have availed excise duty exemption under the Notification and the goods must have been cleared by the manufacturing unit by availing the exemption upto 1.07.2017, i.e., the date of implementation of GST. This was a fair and reasonable interpretation of the conditions specified in the BSS. 

The High Court’s interpretation of the conditions led to at least one straightforward conclusion: if the taxpayer was manufacturing the goods and availing exemption before 1 July 2017, it was eligible for BSS. While if it was not manufacturing the goods and not availing the exemption, it was not eligible for budgetary support. In view of the above, the petitioner’s argument seems attractive, i.e., if the goods under the HSN Code 3808 were manufactured by it before introduction of GST, the budgetary support should be available. However, the High Court noted that the second condition also needs to be satisfied, i.e., the goods must have been cleared by availing the exemption. And crucially the exemption could only be availed if the relevant sub-heading under HSN Code 3808 was mentioned alongside the 6-digit or 8-digit code. Thus, under the exemption Notification excise could only be availed for specific goods and not any goods manufactured under the HSN Code 3808. Accordingly, the High Court held that:

… even if any unit manufactures an item now which is covered under the Tariff Head of 3808, if the same had not been manufactured earlier during the subsistence of the Exemption Notification and had not availed excise duty exemption, such good would not qualify for claim of budgetary support under the Scheme. (para 43)

The High Court rejected the petitioners arguments on various grounds. It observed that accepting the petitioner’s argument would make the definition of specified goods redundant. It also observed that the Union was not adding words to the conditions of the BSS, instead it was interpreting the conditions correctly and strictly. And the High Court correctly endorsed the Union’s interpretation of the conditions provided in the BSS. The High Court also adopted a reasonable approach to the dispute and observed that there was no discernible ambiguity in the conditions specified in the BSS. The High Court rejected the petitioner’s claim by holding that the petitioner was adopting a generalised approach while the conditions mentioned in the BSS were specific and clear that did not allow for an interpretive approach adopted by the petitioners to support their claim of tax exemption.    

Conclusion

The High Court’s decision is a successful attempt to adhere to strict interpretation of tax statutes. At the same time, the High Court was clear in its understanding of the scope and aim of BSS. It clarified that the budgetary support is conditional and not a blanket support; to be eligible for BSS, a taxpayer needs to meet the conditions so specified. (para 27) Discounting the need for liberal interpretation of the relevant conditions, the High Court stated that the eligibility was clearly mentioned and rightly concluded that the decision to not extend BSS benefits to the petitioner did not suffer from the vice of illegality or arbitrariness. (paras 49 and 52)           

[1] M/S Best Crop Science Industrial Area, Kathua v Union of India and others 2023 LiveLaw (152).

Possession, Ownership and Valuable Articles: Supreme Court Opines on Section 69A, IT Act, 1961

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On 16 May 2023, a Division Bench of the Supreme Court in M/s DN Singh case[1] delivered a well-reasoned judgment clarifying the scope of Section 69A, IT Act, 1961. The case required the Supreme Court to determine if a person in unlawful possession of bitumen can be equated to an owner and obligated to pay tax for its monetary value under Section 69A. The judgment is elegantly structured and helps us understand the intent and meaning of Section 69A.  

Introduction

The brief facts are as follows: assessee was a carriage contractor for bitumen which was loaded from oil companies to be delivered to various divisions of the Road Construction Department of the Government of Bihar. A scam was reported in the media that transporters were not delivering the requisite quantity of bitumen to the Road Construction Department and were misappropriating it after loading from oil companies. Taking note of the scam, Assessing Officer of the assessee took note of the difference in quantity between the bitumen lifted by the assessee and delivered by it and added the value of missing bitumen to the assessee’s income under Section 69A, IT Act, 1961.   

There were two assessment years in question: in the assessment year 1995-96, an addition was made in a sum of Rs.2,01,14,659 towards short delivery of bitumen while in the assessment year 1996-97 there was an addition in a sum of Rs.1,04,71,720. 

The assessee resisted addition of the amounts on two counts, i.e., bitumen was not a valuable article which was a pre-condition for invoking Section 69A and that the assessee was only a carrier but not owner of the bitumen in question and that Section 69A can only be invoked against owners of the valuable articles. Section 69A, IT Act, 1961 states as follows: 

Where in any financial year the assessee is found to be the owner of any money, bullion, jewellery or other valuable article and such money, bullion, jewellery or valuable article is not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewellery or other valuable article, or the explanation offered by him is not, in the opinion of the 4 Assessing] Officer, satisfactory, the money and the value of the bullion, jewellery or other valuable article may be deemed to be the income of the assessee for such financial year. (emphasis added)

In this post, I will focus on the Supreme Court’s approach towards interpretation of the two terms – owner and other valuable article – used in Section 69A to examine how it understood the scope and intent of the above-cited provision.  

Supreme Court Clarifies the Scope and Intent of Section 69A

The first question was whether the transporter would qualify as an owner of goods which the Supreme Court answered in the negative. The Supreme Court referred to the law relating to bailment and noted that entrustment of goods to the transporter would amount to bailment. The bailee/transporter is necessarily entrusted with the possession of goods for the purpose of delivery as per the directions and wishes of the consignee. Consequently, the Supreme Court held that: 

During the subsistence of the contract of carriage of goods, the bailee would not become the owner of the goods. In the case of an entrustment to the carrier otherwise than under a contract of sale of goods also, the possession of the carrier would not convert it into the owner of the goods. (para 39)

The Supreme Court cited a series of cases which examined the definition of owner in the context of income from house property to emphasise two elements: first, that the definition of ownership needs to be interpreted as per the context e.g., in the case of taxation of an owner from income from house property courts have held that the emphasis was on receipt of income. And an owner must be someone who exercises the right of an owner not on behalf of the owner but in his own right. Second, the Supreme Court emphasised the owner possesses a bundle of rights with respect to a property, e.g., power of possession, right to alienate, right of bequeath and right of enjoyment. (paras 57-58) Applying the above understanding and elements of ownership to the case, the Supreme Court observed that the transporter cannot be considered as owner of bitumen. The Supreme Court reasoned that a transporter by short delivering the bitumen breached the terms of contract and committed an act that was punishable under penal laws. Accordingly: 

Recognising any right with the carrier in law would involve negation of the right of the actual owner which if the property in the goods under the contract has passed on to the consignee is the consignee and if not the consignor. This Court has already found that the appellant is bereft of any of the rights or powers associated with ownership of property. The only aspect was the alleged possession of the goods which is clearly wrongful when it continued with the appellant contrary to the terms of the contract and the law. (para 61)

The Supreme Court found that the assessee was not in possession of bitumen in his own right, did not possess the power of alienation, could not claim any right over bitumen as an owner and the title of assessee was only a shade better than that of the thief. And thereby the Supreme Court refused to accept that the assessee was the owner of bitumen. 

Second question that the Supreme Court had to address was if bitumen constituted a valuable article under Section 69A. It referred to the principle of ejusdem generis and Noscitur a Sociis, and observed that to apply the aforestated principle to interpret a provision there must exist a genus which must not be exhausted by the categories enumerated in the catalogue. The Supreme Court underscored the scope of ‘other valuable article’ by using certain examples. It referred to the fact that watches, coconuts, cameras can or cannot constitute a valuable article depending on the facts of the case, but placed primary emphasis on the price of the goods in question. According to the Supreme Court, the intent was to ascertain if the goods were worth a great deal of money or a great price. Thereby, citing the price of bitumen as Rs 5/kg, it concluded that:

But if to treat it as ‘valuable article’, it requires ownership in large quantity, in the sense that by multiplying the value in large quantity, a ‘good price’ or ‘great deal of money’ is arrived at then it would not be valuable article. Thus, this Court would conclude that ‘bitumen’ as such cannot be treated as a ‘valuable article’. (para 79) 

The Supreme Court adopted the right approach in analysing the scope and intent of Section 69A. It examined in detail the position of a transporter as a bailee, the rights of a bailee vis-à-vis owner and how the former cannot be equated to an owner in the impugned case. More importantly, the Supreme Court never lost sight of the intent of Section 69A when interpreting the terms owner and other valuable article, ensuring that its interpretation of both terms was in the proper context and furthered the objective that the provision seeks to achieve. 

Notes on Concurring Opinion 

In his concurring opinion, Justice Hrishikesh Roy examined the term other valuable article in detail and made three important observations: 

First, that he observed that if one focuses on the words money, bullion and jewellery that precede other valuable article, it is justified to include only high value goods. And that if sundry articles of nominal value are included or if one emphasises on total high value of goods without looking at their low per unit price, it would defy the logic of legislature. (para 10) 

Second, he stated that the provision was unambiguous and needs to be interpreted strictly – a well-established dictum in tax law interpretation. Thus, other valuable article cannot be interpreted to mean ‘any article of value’ but means an item ‘worth great deal of money’. He reasoned that other valuable article has to be a high-priced article that was purchased to avoid income tax liability and not every article of any value. (para 15)  

Third, he correctly observed that high value and less bulky items that aided assesses in evading their income tax liabilities were intended to be brought within the scope of Section 69A and were the reason for 1964 Amendment to introduction of the impugned provision. (para 17) 

Justice Roy, in his concurring opinion, was able to successfully highlight the intent, scope and meaning of Section 69A. The concurring opinion is worth reading for its precision and its adds considerable value to the case and helps us understand the history, scope and meaning of Section 69A clearly.  

Conclusion 

The Supreme Court through its judgment has articulated the scope of Section 69A sufficiently clearly. Equally, the judgment also adequately refers to the intent of the provision, i.e., to bring within the income tax net assets that an assessee may purchase or otherwise own and hides from the income tax authorities. Any article can be of value, the question was whether the article in question was worth enough money to enable a person to escape income tax liability. And more appropriately, the Supreme Court observed that it is not important to ascertain the total value of the goods, but need is to look at per unit value of goods else the objective of Section 69A would not be served.   

[1] M/s D.N. Singh v Commissioner of Income Tax, Central, Patna & Anr 2023 LiveLaw (SC) 451. 

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.     

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

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

Changes Introduced by the Finance Act, 2023 

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

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

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

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

Clarifications Issued Via the CBDT Circular  

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

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

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

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

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

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

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

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

Conclusion  

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

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

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

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

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

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

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

Core Issue 

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

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

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

            Actionable claims, other than lottery, betting and gambling. 

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

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

Revenue Department Makes Incredulous Arguments 

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

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

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

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

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

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

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

Karnataka High Court Dismisses the Revenue’s Case  

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

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

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

Way Forward 

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

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

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

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

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

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

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

Background to the Writ Petition  

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

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

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

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

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

Petitioner’s Arguments

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

High Court Accepts Petitioner’s Arguments 

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

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

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

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

Conclusion

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

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

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

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Introduction 

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

Arguments About the Scope of Section 153A

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

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

The Second Proviso, is worth citing in full: 

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

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

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

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

Delhi High Court’s Interpretation Approved by the Supreme Court

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

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

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

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

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

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

‘Remedy’ to the Revenue 

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

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

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

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

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

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

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

Statutory Provisions and Relevant Arguments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

IGST on Ocean Freight Runs into the Hurdle of Double Taxation

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

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

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

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

Conclusion 

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

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

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

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

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

Introduction

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

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

Using Legislative History as an Aid to Constitutional Interpretation

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

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

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

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

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

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

Bifurcating Recommendations into Two Categories 

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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