Ocean Freight Archives

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

August 1, 2023May 21, 2023 by Rav Singh

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

August 1, 2023May 21, 2023 by Rav Singh

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 101^st 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 101^st 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 101^st 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.