Supreme Court

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

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

Facts 

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

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

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

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

Legal Issue and Arguments 

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

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

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

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

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

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

Supreme Court’s Observations on Section 19 

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

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

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

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

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

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

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

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

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

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

Conclusion 

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

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

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

No Advertisement Tax on Name Boards or Sign Boards

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In a recent judgment[1], the Supreme Court set aside demand notices for advertisement tax issued by the Indore Municipal Corporation against the appellant. The demand notices for advertisement tax were issued to the appellant because they had displayed their name/sign boards outside their business premises which the Municipal Corporation deemed to be advertisement and thus liable to pay advertisement tax. The Supreme Court opined on the meaning of advertisement, cited relevant precedents, and concluded that sign boards do not constitute advertisements and are not exigible to advertisement tax. 

Facts 

The appellant in the impugned case was occupier of premises on AB Road, Indore and was carrying on the business of Hyundai passenger cars at the said premises. The appellant had displayed its trade name as well as the product and services offered by it in the premises where the business was being run. The Indore Municipal Corporation issued a notice to the appellant for recovery of advertisement tax for displaying the sign board at its premises. The notice was issued under the relevant Municipal Corporation statute read with the relevant Municipal Corporation advertisement by-laws. 

The appellant objected to the notice demanding advertisement tax on the ground that it was not displaying any advertisement but its own trade and business name. The appellant also argued that it was carrying on business outside the municipal limits of Indore and thus no tax was leviable on its activities. Appellant’s writ petition against the notices was rejected by the Madhya Pradesh High Court and it appealed before the Supreme Court. 

Arguments 

The appellant assailed the Madhya Pradesh’s judgment on various grounds: first, that the High Court relied on Bharti Airtel judgment[2] which was irrelevant to the facts at hand; second, mere display of name and business cannot amount to advertisement as the said information is only for identification purposes and providing information to the general public; third, the appellant contended that levy of advertisement tax on trade name would amount to violation of Article 19(1)(a) and Article 19(1)(g) of the Constitution 

The State, on the other hand, contended that appellant’s displaying their trade name along with the products and services offered by them amounted to advertisement as the said information was communicated to the public not only for information purposes but also for commercial exploitation. 

Supreme Court Opines on Meaning of ‘Advertisement’

The Supreme Court framed the primary issue as: whether display boards, sign boards or name boards as displayed by the appellants would constitute as advertisements? The incidental question, as per the Supreme Court, was whether all modes of display would amount to advertisement? To answer this question, the Supreme Court relied heavily on the ICICI Bank case[3] where the meaning of advertisement in a comparable context had been examined. The Supreme Court in ICICI Bank case had noted that an advertisement should have a commercial purpose or exposition and should indicate business of the displayer with a view to attract people to its goods or services. The Supreme Court in ICICI Bank case opined on the issue of whether signs that illuminated ATM centres would constitute as advertisements. It did not give a clear answer and observed that signs of ATMs provide information to public as to a facility available at the said place but could also be used indirectly for commercial exploitation for commercial purposes. And the answer to this issue would depend on facts of each case. 

The Supreme Court said the guidelines in in ICICI Bank case, would prima facie indicate that in the impugned case:  

… as dealers of Tata Motors and Hyundai Vehicles appellants have displayed their name board of respective business establishment which is also depicting the nature of the respective vehicles which are being sold and it would be inseparable part of the appellants’ business establishment. By mere mentioning the name of the product in which the business establishment is being run would not partake the character of the advertisement until and unless by such display customers are solicited. (para 18)

 The Supreme Court added that in the absence of any name board or sign board it would be impossible to identify establishments and the sign boards displayed by appellants on their business premises only provide general information of the products offered by them and not to solicit customers or induce general public to purchase their products.  

Finally, the Supreme Court made a curious statement. It noted that under the relevant statutory provisions the Municipal Corporation was not authorized to demand tax for display of information through name boards. And that legislative was not to levy tax on sign boards but only on advertisements. It then noted that:

            Even in such circumstances, it is held that it amounts to advertisement, such levy would be without authority of law and would find foul of Article 19(1)(a), 19(1)(g) and Article 265 of the Constitution of India. (para 18) 

Does the above cited sentence mean that a sign board even if amounts to advertisement would not have been taxable under the relevant provisions? It is a curious sentence since it renders futile the entire argument made by the State. If the State, under the relevant provisions, could not tax a sign board even if it amounted to an advertisement what was the need to distinguish a sign board from an advertisement?  

Conclusion 

Presuming that distinguishing a sign board from an advertisement was crucial in the impugned case, it cannot be denied that distinguishing a sign board from an advertisement is a fraught exercise and the Supreme Court in ICICI Bank case was correct in laying down the broad parameters and stating that whether a particular information amounts to advertisement or not should be determined on the facts of each case. An attractive display of only the products and services offered by a business could amount to an advertisement in certain cases while it could be understood to be a mere sign board in other cases. In the impugned case, the Supreme Court favored the appellant relying on its assertion that its sign board was only aimed to identify its business and not solicit customers; though the distinction may not be as apparent in all cases. In ICICI Bank case, the Supreme Court noted that the non-commercial element of the illuminated ATM centre was that it was a public facility while in the impugned case the non-commercial element was that the sign board helps the general public identify a business place. It is reasonable to deduce from the above cases that if the non-commercial element dominates and is not intended to solicit customers it can be said to not amount to advertisement though the said issue can only be answered by looking at the signs in each case and after ascertaining the relevant facts. 

[1] M/S Harsh Automobiles Private Limited v Indore Municipal Corporation 2023 INSC 893. Available at https://main.sci.gov.in/supremecourt/2018/3032/3032_2018_8_1502_47486_Judgement_09-Oct-2023.pdf (Last accessed on 12 October 2023).  

[2] Bharti Airtel v State of Madhya Pradesh WP No. 2296 of 2012, decided on 12.01.2015. (This judgment addressed the issue of whether advertisement tax could be collected by appointing agents and was not relevant to the facts of impugned case. It was incorrectly relied on by the High Court and the Supreme Court correctly said that the Bharti Airtel case was irrelevant to the impugned case.). 

[3] ICICI Bank and Another v Municipal Corporation of Greater Bombay (2005) 6 SC 404. 

Supreme Court Reiterates Non-Obstante Clause of Section 529A, Companies Act, 1956

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In a recent judgment[1], the Supreme Court opined on the priority to be accorded to custom authorities vis-à-vis secured creditors under the Companies Act, 1956. It accorded due deference to the overriding nature of Section 529A under which tax due by a company under winding up is not to be the foremost payment. While the judgment is under the erstwhile Companies Act, 1956 it is important to highlight how a seemingly straightforward issue – ranking of tax dues from a company under the winding up or insolvency process – has a unduly long legacy that continues to simmer under the IBC as well. 

Introduction 

The appeal before the Supreme Court was against an order of the Andhra Pradesh High Court where it held that notwithstanding the winding up order against the impugned company – M/s Sri Vishnupriya Industries Limited – and Sections 529A and 530 of the Companies Act, 1956, the custom authorities have the first right to sell the imported goods and adjust the sale proceeds towards payment of customs duty. The appeal was filed by Industrial Development Bank of India from which the company had sought financial assistance and to which the company had hypothecated movable properties, namely machinery and its components.

The company had imported the machinery and components and on failure to pay the customs duty, an order was passed to detain and sell the said property for satisfaction of the outstanding customs duty. In the meanwhile, an order for winding up of company was passed and the Official Liquidator so appointed requested the custom authorities to hand over the properties of the company which the latter planned to auction for payment of customs duty. The Andhra Pradesh High Court faced with the question as to whether the rights of a secured creditor should have precedence over custom authorities, decided in favor of the latter.    

Interplay of Provisions of Companies Act, 1956

Supreme Court was categorical, and rightly so, in its examination of Section 529A of Companies Act, 1956. It noted that Section 529A enlisted that workmen’s dues and debts of secured creditors shall be paid in preference to all other payments, and the non-obstante clause in the provision made it clear that these payments were to be made in preference to all other payments in the winding up of a company. And all other payments enlisted in Section 530 were to be made subject to the prescription of Section 529A. Supreme Court concluded that it is ‘beyond debate’ that provisions of Section 529A shall prevail of Section 530 of the Companies Act, 1956. (para 11)

The result of this clear and unambiguous position and effect of both provisions, was, in Supreme Court’s own words: 

… IDBI is an overriding preferential creditor under Section 529A of the Companies Act and at best, if the requirements of clause (a) to Section 530(1) of the Companies Act are satisfied, the customs dues would fall under Section 530 of the Companies Act and will be categorized as preferential payment. (para 19) 

The Supreme Court, out of abundant caution, went into the meaning and interpretation of certain phrases used in Section 529A and Section 530, Companies Act, 1956. It went into detail and cited precedents as to what the terms ‘due’ and ‘due and payable’ mean under the provisions. 

The Supreme Court then clarified that as per the law laid down in relevant precedents, such as the Dena Bankcase[2], government dues do not have priority over secured creditors. The principle so enunciated in the Dena Bank case aligned with the Supreme Court’s interpretation and interplay of Section 529A and Section 530 in the impugned case. However, the Supreme Court clarified that the principle laid down in the Dena Bank case must give way to a statutory charge that may be created by an enactment. In the context of impugned case, it meant that the Supreme Court had to examine if Customs Act, 1962 created a first charge for payment of customs duty and if there was a conflict between the Companies Act, 1956 and Customs Act, 1962. Supreme Court’s conclusion on this point was: 

The provisions in the Customs Act do not, in any manner, negate or override the statutory preference in terms of Section 529A of the Companies Act, which treats the secured creditors and the workmen’s dues as overriding preferential creditors; and the government dues limited to debts ‘due and payable’ in the twelve months next before the relevant date, which are to be treated as preferential payments under Section 530 of the Companies Act, but are ranked below overriding preferential payments and have to be paid after the payment has been made in terms of Section 529 and 529A of the Companies Act. Therefore, the prior secured creditors are entitled to enforce their charge, notwithstanding the government dues payable under the Customs Act. (para 24)

The Supreme Court further clarified that the charge created under Section 142A, Customs Act, 1962 protects the rights of third parties under Section 529A, Companies Act, 1956 inter alia of those under Insolvency and Bankruptcy Code, 2016. And that Section 142A, Customs Act, 1962 does not create a first charge on the dues payable under the said legislation.         

Conclusion

While the Supreme Court’s judgment focuses on the interplay of provisions of Companies Act, 1956, its observations in the latter half of the judgment clarify, to some extent, the position of law after the implementation of IBC. The fact that Customs Act, 1962 does not create a statutory charge is an important and correct position of law as it clarifies that tax authorities – at least, customs authorities – are not placed above the preferential creditors. This may prove useful in unfortunate but frequent disputes between tax authorities seeking priority payment of outstanding dues over secured creditors of the company under insolvency, despite that the waterfall mechanism under IBC does not place the tax authorities above the secured creditors.  

[1] Industrial Development Bank of India v Superintendent of Central Excise and Customs and Others, available at https://main.sci.gov.in/supremecourt/2009/114/114_2009_3_1501_46202_Judgement_18-Aug-2023.pdf (Last accessed on 21 August 2023). 

[2] Dena Bank v Bhikhabhai Prabhudas Parekh & Co and Others (2000) 5 SCC 694. 

Interface of IBC and Tax: Supreme Court Clarifies

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In a notable judgment[1], the Supreme Court has clarified the waterfall mechanism under Insolvency and Bankruptcy Code, 2016 (‘IBC’) vis-à-vis the claims of secured interests and the place of the Revenue Department in the pecking order. 

Introduction 

The appellant, PVVNL was aggrieved by an order of the NCLAT directing release of the corporate debtor’s property. The property was attached by the District Magistrate in favor of the appellant, but NCLAT ordered its release for sale in favor of the liquidator to distribute the proceeds in accordance with the IBC.  

The appellant raised bills for supply of electricity to corporate debtor but since the bills remained unpaid, the appellant attached the properties of the corporate debtor and restrained transfer of property by sale, donation, or any other mode. The corporate debtor underwent a resolution under IBC failing which it became subject to liquidation. The liquidator took the plea that unless the attachment orders were set aside no one would purchase the property of the corporate debtor. Further, the appellant would be classified in the order of priority prescribed under waterfall mechanism of IBC. Both, NCLT and NCLAT endorsed the view that appellant was an operational creditor and would realize its due in the liquidation process as per the law.   

Arguments and Supreme Court’s Observations 

One of the appellant’s arguments was that the charge on property was created under the Electricity Act, 2003 and it being a special legislation should have priority over general legislation such as IBC. Supreme Court did not accept the appellant’s argument claiming priority of Electricity Act, 2003 over IBC. However, Supreme Court acknowledged that a reading of the relevant provisions of the agreement between the appellant and corporate debtor revealed that the appellant could create a charge on the property of the latter in event of unpaid bills. And that a valid charge was created in favor of the appellant. The crucial question was the priority that the appellant would acquire under the IBC. 

The counsel for liquidator argued that the amount due to the appellant was ‘government dues’ and low in priority as per the waterfall mechanism of Section 53, IBC. Supreme Court disagreed and noted that dues payable to statutory corporations were on a different footing compared to the amounts payable to the central and state governments. Supreme Court observed that: 

PVVNL undoubtedly has government participation. However, that does not render it a government or a part of the ‘State Government’. Its functions can be replicated by other entities, both private and public. The supply of electricity, the generation, transmission, and distribution of electricity has been liberalized in terms of the 2003 Act barring certain segments. Private entities are entitled to hold licenses. In this context, it has to be emphasized that private participation as distribution licensees is fairly widespread. For these reasons, it is held that in the present case, dues or amounts payable to PVVNL do not fall within the description of Section 53(1)(f) of the IBC. (para 47)

The appellant – PVVNL – on the other hand, relied on Rainbow Papers case which had held that the debts owed to a secured creditor included tax due to the Government under the Gujarat VAT Act, 2003. The Rainbow Papers case was an anomaly as the waterfall mechanism clearly prescribes priority to secured creditors while placing the government dues lower in the pecking order. The Supreme Court refused to adhere to the Rainbow Papers case and observed that the Court in that case ‘did not notice’ Section 53, IBC. Commenting on the Rainbow Papers case, Supreme Court observed:

Furthermore, Rainbow Papers (supra) was in the context of a resolution process and not during liquidation. Section 53, as held earlier, enacts the waterfall mechanism providing for the hierarchy or priority of claims of various classes of creditors. The careful design of Section 53 locates amounts payable to secured creditors and workmen at the second place, after the costs and expenses of the liquidator payable during the liquidation proceedings. However, the dues payable to the government are placed much below those of secured creditors and even unsecured and operational creditors. This design was either not brought to the notice of the court in Rainbow Papers (supra) or was missed altogether. In any event, the judgment has not taken note of the provisions of the IBC which treat the dues payable to secured creditors at a higher footing than dues payable to Central or State Government. (para 49)

The above observations are a categorical rejection of the inadequate reasoning adopted in Rainbow Paperscase whereby government was equated as a secured creditor and helped the government claim tax dues on priority by ‘jumping’ the queue. The Supreme Court in the impugned case was accurate in its observation that if there was no specific and separate enumeration of government dues under Section 53(1)(e) of IBC, it would be possible to hold that the government is a secured creditor. However, the enumeration of separate categories of a secured creditor and government dues under Section 53 indicates the Parliament’s intent to treat the latter differently and at a lower priority. 

Conclusion

The Supreme Court’s observations in the impugned case are welcome. The Revenue has in various attempts tried to bypass the waterfall mechanism of IBC by making various arguments such as tax dues should be treated as part of the insolvency costs as the latter are first in priority under the waterfall mechanism. It is important to recognize the importance of the observations in in the impugned case and yet be mindful that the Supreme Court has not expressly overruled the Rainbow case. For example, the Supreme Court did add that the observations made in the Rainbow case were in the context of resolution process while the impugned case involved liquidation. (para 49) We are likely to witness more disputes on the interface of IBC and tax in the future. Though, a more reasonable interpretation of the waterfall mechanism under Section 53, IBC suggests that the Supreme Court’s observations in the impugned case are more reasonable and accurate.     

[1] Paschimanchal Vidyut Vitran Nigam Limited v Raman Ispat Private Limited 2023 LiveLaw (SC) 534. 

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. 

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

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Introduction 

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

Arguments About the Scope of Section 153A

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

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

The Second Proviso, is worth citing in full: 

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

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

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

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

Delhi High Court’s Interpretation Approved by the Supreme Court

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

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

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

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

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

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

‘Remedy’ to the Revenue 

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

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

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

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

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

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

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

Statutory Provisions and Relevant Arguments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

IGST on Ocean Freight Runs into the Hurdle of Double Taxation

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

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

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

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

Conclusion 

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

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

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

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

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

Introduction

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

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

Using Legislative History as an Aid to Constitutional Interpretation

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

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

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

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

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

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

Bifurcating Recommendations into Two Categories 

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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

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

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

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

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

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

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

Interpretation of Amended Section 153C, IT Act, 1961      

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion 

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

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

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

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

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

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

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

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

Facts and Issues 

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

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

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

Summary of Jurisprudence 

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

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

No Substantial Addition to the Jurisprudence  

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

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

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

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

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

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

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

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

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