The nine-judge Constitution Bench of the Supreme Court pronounced its judgment on the issue of validity of Entry Tax on 11 November 2016. The judgment is of immense significance as it not only examines the power of the state legislatures to levy such taxes, but also clarifies the import of the provisions contained in Part-XIII of the Constitution of India, which deals with “Trade, Commerce and Intercourse within the Territory of India.” The judgment also clarifies the position on the contours of discriminatory taxes, especially in the context of inter-state movement of goods. The Supreme Court has correlated the powers of the states to levy such taxes to the sovereignty of the states in the existing quasi-federal scheme of governance in India. The state and Central levies on tax on goods and services are proposed to be merged into a single composite levy of Goods and Services Tax (GST) and Entry 52 of List II of the Seventh Schedule to the Constitution of India giving power to levy Entry Tax has now been deleted by way of the 101st Constitutional Amendment Act, 2016. While this judgment has far-reaching consequences for the past, it may not be of relevance for the future when the GST regime is ushered in, under which the Centre and the states have been given concurrent powers of taxation on goods and services.
Facts and Procedural History of the Litigation
In 2000, the State of Haryana enacted the Haryana Local Development Act (the Act). The purpose of the Act was to provide for levy of a tax on the entry of goods into local areas within the state of Haryana. Subsequently, the constitutional validity of the Act was challenged before the Punjab and Haryana High Court. The Punjab and Haryana High Court dismissed the constitutional challenge on the ground that the levy was compensatory in character and hence not violative of Article 301 of the Constitution of India.
The correctness of the said decision was challenged before the Supreme Court in Jindal Stripe Ltd. and Anr. v. State of Haryana and Ors.1. On hearing the case at length, a two-judge Bench of the Supreme Court referred the matter to a larger Bench as it noticed an apparent conflict between its pronouncements in Atiabari Tea Co. Ltd. v. State of Assam2 (Atiabari) and Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan and Ors.3 (Automobile Transport) on the one hand and M/s. Bhagatram Rajeev Kumar v. Commissioner of Sales Tax4 (Bhagatram) and State of Bihar and Ors. v. Bihar Chamber of Commerce and Ors.5 (Bihar Chamber of Commerce) on the other. Consequently, the matters were placed before a five-judge Constitution Bench of the Supreme Court in Jindal Stainless Ltd. (2) and Anr. v. State of Haryana and Ors.6 (Jindal Stainless Ltd. ), which resolved the conflict by holding that the “working test” propounded by seven judges in the Automobile Transport case was incompatible with the test of “some connection” enunciated by the three-judge Bench in the Bhagatram case. The Supreme Court held that the test of “some connection” as propounded in the Bhagatram case was contrary to the concept of compensatory taxes laid down by the earlier larger Benches of the Supreme Court.
Accordingly, the Supreme Court overruled its earlier decisions rendered in Bhagatram and Bihar Chamber of Commerce and held that the doctrine of “direct and immediate effect” of the impugned law on trade and commerce under Article 301 as propounded in Atiabari and the “working test” enunciated in Automobile Transport for deciding whether a tax is compensatory or not will continue to apply. Further, in light of its judgment, the Supreme Court directed the High Courts to test the constitutional validity of various Entry Tax legislations that were the subject-matter of pending appeals, special leave petitions and writ petitions.
Thereafter, the matters were listed before a Division Bench of the Supreme Court for hearing of the appeals in the light of the above pronouncement of the Constitution Bench. The Division Bench, however, noticed that although the basic issue revolved around the concept of compensatory tax, the High Courts had not examined it as they had considered themselves bound by the view taken in Bhagatram and Bihar Chamber of Commerce. The Supreme Court further found that in the absence of relevant data before the High Courts, the issue of whether the levies were compensatory could not have been considered, and accordingly remanded the matter back to the High Courts to decide on that aspect.
The matters were accordingly taken up by the High Courts, which followed divergent approaches to test the constitutional validity of the impugned levies. While some High Courts strictly confined themselves to the issue as to whether the levies were compensatory in nature or not, other High Courts decided the constitutional validity of the impugned levies with reference to Article 304 (a) and (b) of the Constitution of India also and rendered categorical findings on the discriminatory nature of the levies in the various states.
All these judgments and orders of the High Courts came to be challenged before the Supreme Court. The appeals were listed before a Division Bench of the Supreme Court in Jaiprakash Associates v. State of M.P. & Ors7 (Jaiprakash Associates), which, after expressing doubts as to the very concept of “compensatory taxes” vis-à-vis Part-XIII of the Constitution of India, referred the matter for an authoritative pronouncement by a Constitution Bench. The Division Bench in Jaiprakash Associates had formulated a set of 10 questions for consideration of the Constitution Bench and, thereafter, two more questions were added by the five-Judge Constitution Bench in Jindal Stainless Ltd. & Anr. v. State of Haryana & Ors.8, referring the matter to a larger Constitution Bench.
In July 2016, on the orders of the Chief Justice T.S. Thakur, a nine-judge Constitution Bench of the Supreme Court was constituted, which reframed the questions as follows for determination:
- Can the levy of a non-discriminatory tax per se constitute infraction of Article 301 of the Constitution of India?
- If the answer to Question No. 1 is in the affirmative, can a tax which is compensatory in nature also fall foul of Article 301 of the Constitution of India?
- What are the tests for determining whether the tax or levy is compensatory in nature?
- Is the Entry Tax levied by the States in the present batch of cases violative of Article 301 of the Constitution and in particular have the impugned State enactments relating to entry tax to be tested with reference to both Articles 304 (a) and 304 (b) of the Constitution for determining their validity?
Judgment of the Supreme Court
Split Verdict of 7:2
Among the issues deliberated by the nine judges, there are divergent conclusions on the issue of whether non-discriminatory tax per se constitutes a restriction on the right to free trade, commerce and intercourse guaranteed under Article 301 of the Constitution of India. While the majority decision is rendered by Chief Justice T.S. Thakur along with Justices A.K. Sikri, A.M. Khanwilkar, S.A. Bobde, Shiva Kirti Singh, N.V. Ramana and R. Banumathi, the minority decision, on the other hand, is rendered by Justices Dr. D.Y. Chandrachud and Ashok Bhushan. Further, on the issue of discriminatory taxation being unconstitutional, the conclusions of the nine judges are unanimous; however, the reasons are separate. In this regard, the relevant divergent views expressed by the Bench, in relation to the abovementioned four questions involved in the reference, are mentioned herein below.
Re: non-discriminatory taxes constituting a restriction under Article 301 of the Constitution of India
The first issue considered by the Bench was in relation to the scope and ambit of Part-XIII of the Constitution of India. While answering the question, the majority judgment lays down various important principles with respect to the interpretation of Part-XIII and the powers of the states to impose restrictions on the freedom of trade and commerce, which are as follows:
- The power to levy taxes has been universally acknowledged as an essential attribute of sovereignty.
- In terms of the powers granted to the states under the Constitution of India, the power to tax cannot be deducted from a general legislative entry.
- The sovereign exercise of power to impose tax, however, is subject to constitutional limitations, which ought to be express.
- There is no specific limitation on the states’ power to levy taxes on import of goods from other states except the one referred to in Article 304 (a), which itself is confined to the levy of discriminatory taxes.
- So long as taxes are non-discriminatory and, therefore, consistent with Article 304 (a), there is no limitation leave alone any express limitation to levy any tax on the import of goods from another state.
- The freedom of trade, commerce and intercourse in terms of Article 301 is not absolute but is subject to the provisions of Part-XIII.
- Article 301 does not work as an impediment on the states’ taxing powers except in situations where such taxes fall foul of Article 304 (a). This contextual approach fully matches with the textual interpretation placed on Part-XIII.
- The expression “subject to the provisions of this Part” appearing in Article 301 and the non-obstante clause appearing in Article 304 do not traverse in different directions, and there is no conflict on this account. These two expressions simply mean that Article 304 takes precedence over Article 301.
- The mere fact that a tax, on being at an unreasonably high rate, casts a heavy burden is no reason for holding that it is a restriction on the freedom of trade and commerce. Any such excessive tax burden may be open to challenge under Part-III of the Constitution, but the extent of the burden would not by itself justify the levy being struck down as a restriction contrary to Article 301 of the Constitution.
Accordingly, the majority view has held that a non-discriminatory tax does not per se constitute a restriction on the right to free trade, commerce and intercourse guaranteed under Article 301 of the Constitution of India. Supplementing the conclusions, S.A. Bobde J. has observed that Entry Tax is itself predicated on the freedom of trade and commerce and, therefore, cannot be viewed as a restriction on the freedom of trade and commerce.
Further, in his judgment, N.V. Ramana J. has held that the use of the expressions, “Subject to the other provisions of this part,” “trade, commerce and intercourse throughout the territory of India” and “shall be free” in Article 301 of the Constitution of India makes it clear that Article 301 is merely a clarificatory provision, which is subject to the other provisions of Part-XIII. He has further noted that Part-XIII of the Constitution does not contemplate tax laws within its ambit except to the extent indicated in Article 304 (a) because in Part-XIII, no other Article deals with taxes except Article 304 (a).
R. Banumathi J. has also agreed with the conclusions of the majority that non-discriminatory taxes per se do not constitute a restriction on the right to freedom of trade, commerce and intercourse guaranteed under Article 301.
On the other hand, in dissenting views expressed by Dr. D.Y. Chandrachud, J. and Ashok Bhushan, J., it is opined that a non-discriminatory tax could amount to a restriction on the freedom of trade, commerce and intercourse if the direct and inevitable effect of the same was to impede trade and commerce as a whole. According to the minority view, Article 304 (a) of the Constitution of India cannot be construed to mean that only discriminatory taxes amount to restrictions on the freedom of trade, commerce and intercourse guaranteed by Article 301.
Re: compensatory taxes
After having answered in the negative that the levy of a non-discriminatory tax constitutes an infraction of Article 301 of the Constitution of India, the judgment also determines the issue of “compensatory taxes” vis-à-vis Part-XIII of the Constitution of India.
In respect of this issue, the views of all judges, except that of Justice R. Banumathi, were unanimous. All judges, except Banumathi J., agreed that the “compensatory tax” theory evolved by the Supreme Court in Automobile Transport had no constitutional basis. By majority, the decision in Automobile Transport and subsequent decisions following the dictum evolved in Automobile Transport with respect to the concept of “compensatory taxes” are consequently overruled. Therefore, all judgments that had struck down Entry Tax legislations on the ground that the tax was not compensatory in nature stand overruled.
Therefore, all judgments that had struck down Entry Tax legislations on the ground that the tax was not compensatory in nature stand overruled.
Justice R. Banumathi held contrary views on this issue. According to opinion expressed by her in the judgment, the “compensatory tax” theory ought to be continued as it was correct and, further, had withstood the test of time. Banumathi J. further held that the test of “some connection” enunciated in Bhagatram and Bihar Chamber of Commerce was the correct test in determining the compensatory nature of a levy.
Re: Entry Tax and Articles 304 (a) and (b) of the Constitution of India
The last issue concerning the reference was in relation to clauses (a) and (b) of Article 304 of the Constitution of India — whether a state enactment relating to Entry Tax had to be tested with reference to both Articles 304 (a) and (b) of the Constitution of India. According to the majority decision, the constitutional validity of any taxing statute could only be tested with Article 304 (a) of the Constitution of India. It is held that the “restrictions” referred to in Article 304 (b) are non-fiscal in nature and the said provision does not deal with taxes as restrictions. Accordingly, the constitutional validity of any taxing statute has to be tested only on the anvil of Article 304 (a) and if the law is found to be non-discriminatory, it can be declared to be constitutionally valid without the legislation having to go through the test of Article 304 (b). However, should the statute fail the test of non-discrimination under Article 304 (a), it must be struck down as it cannot be sustained even if it had gone through the process stipulated by Article 304 (b).
While dealing with various aspects of Article 304 (a) and while holding that discriminatory taxation is forbidden under Article 304 (a), the majority decision has discussed various important aspects of discriminatory fiscal legislations. Even while the ultimate decision as to whether the levies are violative of Part-XIII, which were the subject-matter of the litigation before the Supreme Court, has been left to be determined by regular Benches hearing the matters, important tests have been laid down to ascertain whether a tax is discriminatory or not. The tests and important observations, in this regard, are summarized as under:
- Article 304 (a) itself recognizes the availability of the power to impose taxes on goods imported from other states. Only such taxes as are discriminatory in nature are prohibited by Article 304 (a). It, therefore, follows that the levy of a discriminatory tax would only constitute an infraction of Article 301.
- Importantly, as held in Video Electronics v. State of Punjab9 (Video Electronics), there is a difference between differentiation and discrimination and every differentiation is not discrimination. The “discrimination” referred to in Article 304 (a) refers to discrimination of a hostile nature — i.e., where the differentiation made is inspired by an element of unfavorable bias in favor of goods produced or manufactured in the state as against those imported from outside.
- Any challenge to a fiscal enactment on the touchstone of Article 304 (a) must be tested by the standard as laid down in Kathi Raning Rawat v. The State of Saurashtra10. The Court ought to examine whether the differentiation made is intended or inspired by an element of unfavorable bias in favor of the goods produced or manufactured in the state as against those imported from outside.
- The levy of Entry Tax on import of goods from outside the state will not be discriminatory if the goods so imported or similar are not produced or manufactured within the state, as the power of the state legislature to levy such tax on such imported goods flows from Articles 245 and 246, read with the entries in the three lists contained in Schedule VII to the Constitution of India and not Article 304 (a) of the Constitution of India.
- The power to grant exemptions is a part of the sovereign power of the state to levy taxes. It cannot be taken away from the states that are otherwise competent to impose taxes and duties.
- The grant of incentives and exemptions with a view to promote industrialization in the backward areas of a state is permissible under Part XIII of the Constitution of India.
On the basis of the aforementioned principles, the majority view has upheld the tests laid down in Video Electronics, and the question of satisfaction of the tests in individual cases has been left open for determination by regular Benches. Apart from the aforementioned principles on discrimination, another important aspect that has been discussed in the majority opinion relates to the differential rates of Entry Tax being imposed by various states on imported goods vis-à-vis locally manufactured goods. Most of the states were granting setoff/exemption/adjustment/credit to goods that were locally produced or manufactured. The judgment by majority holds in this regard that so long as the intention behind the grant of exemption/adjustment/credit is to equalize the incidence of the fiscal burden on the goods from within the state and those from outside the state, such exemption or set off will not amount to hostile discrimination offensive to Article 304 (a).
S.K. Singh, J. on the issue of discriminatory taxes, while agreeing with the majority view, has held that the imposition of tax by state legislatures must, in essence, be non-discriminatory, both in the ultimate tax burden and the machinery provisions.
N.V. Ramana, J., while agreeing with the majority view, has also supplemented the reasoning on the issue of grant of exemptions by the states. He has held that the grant of incentives and exemptions with a view to promote industry in a backward area in a state is permissible under Part XIII of the Constitution of India. Such measures by state governments do not attract the vice of “discrimination” envisaged in Article 304 (a), they are meant to ensure economic equality, which is a facet of economic unity guaranteed under Article 301. He has also observed that Article 304 (a) only prohibits the levy of tax that would result in discrimination between goods imported from other states and similar goods manufactured or produced within the state. This provision does not prohibit the levy of tax in the situation where the imported goods are not manufactured or produced within the state and, further, does not affect the authority of the state to tax the imported goods.
R. Banumathi, J. has also agreed with the majority view. While agreeing that “differentiation” and “discrimination” are different, she has opined that Article 304 (a) of the Constitution of India prohibits “discrimination” and not “differentiation.” Therefore, any difference in the rate of tax on goods locally manufactured and those imported does not offend Article 304 (a). Likewise, the grant of incentives or benefits of concession in the rate of tax given to local manufacturers or producers in order to encourage local manufacturing or production in the backward areas of a state is not violative of Article 304 (a) of the Constitution of India.
Views expressed by Dr. D.Y. Chandrachud, J. and Ashok Bhushan, J.
While both Chandrachud, J. and Bhushan, J. have concluded that discriminatory taxes violate Article 304 (a), the tests adopted by the majority view to ascertain whether a levy is discriminatory in nature or not do not appear to be clearly adopted by the two judges.
Chandrachud, J., in his separate opinion on the issue of discriminatory taxes, has made the following main observations:
- The principle which underlies clause (a) of Article 304 is non-discrimination between goods imported from another state and goods produced or manufactured within. Clause (a) enables the state legislature to impose a tax on goods imported, in the exercise of its legislative power, so long as that tax is imposed also on similar goods manufactured or produced within. The latter part of clause (a), which contains a mandate against discrimination, must have some meaning. In drafting the provision, the founding fathers evidently did not confine it merely to a norm providing a parity of taxes between imported goods and similar goods produced or manufactured within. While stipulating that “any tax” to which similar goods produced or manufactured in the state are subject can be imposed on goods imported into the state from other states, clause (a) contains the mandate that there should be no discrimination between goods that are imported and goods that are manufactured within.
- While granting incentives, the state government must ensure that the underlying spirit of Article 304 (a) is not defeated.
- Article 304 (a) of the Constitution of India does not prohibit a state from making a reasonable classification. Thus, while a state will undoubtedly have a legitimate interest in granting incentives, the grant of such incentives should be carefully structured so as not to defeat the underlying spirit and object of Article 304 (a), which is to prevent states from following policies of protectionism that destroy the essential freedom of trade and commerce.
- Plainly, if a tax is imposed on goods that are imported from other states without subjecting similar goods produced or manufactured within the state to the tax, there would be a violation of Article 304(a). This would constitute an unconstitutional discrimination between goods imported from other states, which are subject to tax, and goods produced or manufactured within the state, which are not subject to the levy.
- If a higher rate of tax is imposed on goods originating in other states that are imported into the taxing state, it would result in a discrimination against imported goods. Such discrimination is sought to be obviated by the requirement that the rate of tax should be the same as between similar goods produced or manufactured within the taxing state and goods imported from other states.
Ashok Bhushan, J., in his separate opinion on the issue of discrimination, observes that state legislature, in exercise of its taxing power, can grant exemptions/set-offs to locally manufactured and produced goods. However, such grant of exemptions/set-offs has to be based on intelligible differentia and for a specific purpose and time period. An exemption granted by the state to locally manufactured and produced goods in general terms without specifying the duration of the exemption will be violative of Article 304 (a) of the Constitution.
Apart from addressing the aforementioned four core issues concerning the reference, the Constitution Bench has also expressed its opinion on certain other issues that had arisen during the course of hearing as a result of the submissions made by the parties. These additional issues relate to the powers of the states to levy Entry Tax on goods imported from outside the county when such goods enter a local area within the state, and whether the entire state can be notified as a “local area.” In this regard, it is relevant to note that even though the majority judgment has refrained from expressing its opinion on the said issues and consequently left it open to be determined by regular Benches when such issues arise in appropriate proceedings, R. Banumathi, Dr. D.Y. Chandrachud and Ashok Bhushan, JJ., in their respective judgments, have expressed views on the said issues. These views have not been subscribed to by the majority judges; they would still be open to be decided at a later stage. The views expressed are as under:
Re: Entry Tax on goods imported from outside the country
The issue as to whether the state legislature is competent to levy Entry Tax on goods imported from other countries has only been dealt with by R. Banumathi, J. in her judgment. According to the opinion expressed by her in the judgment, states are empowered to levy and collect Entry Tax on goods imported from outside the country when such goods enter into a local area within the state, as in terms of Entry 52 of List II, the taxable event is the “entry of goods into a local area,” which is distinct and different from the taxable event envisaged under Entry 83 of List I, wherein goods are subject to tax when they enter into the territory of India. Accordingly, any movement of imported goods into a warehouse established in a factory unit, which is located in a local area within a state, would not prevent the concerned state from levying and collecting Entry Tax.
Re: local area and Entry Tax
Lastly, the issue as to whether the entire state can be notified as a “local area” has been dealt with by R. Banumathi, Dr. D.Y. Chandrachud and Ashok Bhushan, JJ. While R. Banumathi, J. has opined that the term “local area” contemplated in Entry 52 of List II of Schedule VII to the Constitution may cover the “whole state” or “a local area” as notified by the concerned state legislation and has approved the view taken in Bihar Chamber of Commerce to the effect that the local areas covered by an enactment might cover the entire State, Dr. D.Y. Chandrachud and Ashok Bhushan, JJ., on the other hand, have expressed similar divergent views on the said issue to the effect that a “local area” for the purposes of Entry 52 of List II cannot be defined with reference to the entire state but will comprehend an area within a state administered by a local body under the relevant state legislation.
The decision of the Constitution Bench has far-reaching consequences for the trading community. The view of the majority that non-discriminatory taxes per se do not constitute restrictions on the freedom of trade and commerce necessarily implies that state legislatures, in exercise of their law-making powers, could impose a wide range of taxes on trade, commerce and intercourse and such taxes could not be challenged on the grounds of being violative of the freedom guaranteed by Article 301 of the Constitution of India.
The only ground for challenging such levy, which is left after the majority judgment, is of discrimination. Hostile discrimination subsists as a valid ground to challenge a tax as being in violation of Article 304 (a) as well as of Article 14. Further, even while the majority judgment provides for the tests relating to discriminatory taxes, it will be imperative for the assessees to bring out specific grounds to show that the overall differential levy on account of exemption/set-off/rebates etc. is without any rationale or is not mere “differentiation” but leads to a hostile discrimination against the goods manufactured in other states.