Key arguments and observations of the bench

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Introduction

The levy of Entry Tax on entry of goods in a local area has been a hotly contested issue between States and assesses. The Supreme Court of India had referred the matter to a Nine Judge Bench pursuant referral order dated 16 April 2010 by a bench of five judges1. This was to test the legality and validity of Entry Tax on the touchstone of freedom of trade and commerce in India.1 The arguments commenced before the Bench of 9 judges on 19July 2016 and we bring to you the highlights and issues discussed at the hearing of the matter. The matter has been heard for six days as of now and submissions have been made by various senior advocates appearing on behalf of the assessees. Mr. Harish N. Salve argued as leading counsel on behalf of assessees. Senior Advocates Mr. A.K. Ganguli. Mr. T.R. Andhyarujina, Mr. S.K. Bagaria and Mr. Arvind P. Datar also made brief submissions. This note highlights the key submissions made so far and the observations of the Bench.

Quest ions framed by the Bench and circulated in Court

After preliminary arguments on the issue the Bench framed the following questions on the first week of the hearing:

  1. Can the levy of non-discriminatory tax per se constitute an infraction of Article 301?
  2. If the answer is in the affirmative, can a tax, which is compensatory in nature also fall foul of Article 301?
  3. What are the tests for declaring whether the tax or levy is compensatory in nature?
  4. Is the Entry Tax levied by the States (in the present batch of petitions) violative of Article 301, and in particular have the impugned state enactments relating to Entry Tax to be tested with reference to both Article 304(a) and 304(b) of the Constitution for determining their validity?

Furthermore, the Bench formulated certain incidental questions relevant to question no. 1 on the second week of hearing for discussion in the Court of provisions of Article 301 of the Constitution that makes the power to make laws and levy taxes subservient to Article 301 have the effect of denuding the States of their sovereign power and affecting the federal structure envisaged by the Constitution?

  1. Is levy of taxes an attribute of a sovereign State?
  2. If the answer to question No.1 is in the affirmative, does Article 246 of the Constitution of India recognize the sovereign power of States to make laws, including laws levying taxes on subject matters enumerated in Entry II of 7th Schedule?
  3. Is the power to make laws and levy taxes reserved in favor of the States under Article 246 read with List-II subject to Part-XIII of the Constitution?
  4. In case the answer to question No. 3 is in the negative, would any interpretation
  5. Is levy of taxes presumed to be in the public interest?
  6. If the answer to question No.5 is in the affirmative, can levy of taxes be justified as reasonable restrictions imposed in the public interest?
  7. If levy of taxes under Article 304 (b) were permissible only with the previous sanction of the President, would such violative levies not come under judicial scrutiny for determining whether the levy is reasonable and in the public interest?
  8. If the answer to question No.7 is in the affirmative, would it not affect the separation of powers between the legislature on the one hand and the judiciary on the other?
  9. In the absence of anything to show that Article 301 excludes only such taxes as are compensatory in nature, would the compensatory tax theory not bring about a dichotomy that is inconsistent with the language employed in Article 301?

Key submissions of Mr. Salve

Mr. Salve made detailed submissions on the questions preferred to and also on those posed by the Bench. His submissions are as under:

  1. According to the decision of the majority in Atiabari Tea Case2 and the decision in Automobile Transport Case3 only “some taxes” have a direct and immediate effect on the movement of goods under the purview of Article 301. Taxes, which are violative of Article 301, are permitted only in terms of Article 302 and 304 of the Constitution of India, which are enabling provisions. These carve out an exception from the limitation of Article 301. If States impose any limitation or conditions on the entry of goods from another state it will amount to an internal barrier.
  2. He referred to and relied on the minority judgment of Justice Hidayatullah, in Automobile Transport Case, wherein, it was opined that if taxes are compensatory and in public interest, then, they should be saved under Article 304 (b), instead of being called compensatory and taken outside the purview of part XIII.
  3. The Constitution of Australia states that trade will be absolutely free. However, unlike the Australian Constitutions, Articles 302, 303 and 304 of the Constitution of India define the extent of freedom defined in Article 301. Under our Constitutions the Courts cannot devise any scheme to carve out exceptions such as compensatory taxes from Article 301 and render Articles 302, 303 and 304 otiose.
  4. According to the minority view in Automobile Transport Case any regulatory or compensatory legislation/tax must only be saved by Article 304(b). The Courts are incorrect in excluding compensatory taxes from the purview of Article 301, since there might arise a situation wherein a compensatory tax, which is a discriminatory tax (which is completely prohibited) will be saved by such an approach of the Courts. The theory that compensatory taxes are sub set of fee4, is incorrect and redundant in light of the express provisions of Part XIII of the Constitution of India.
  5. Without the presence of Article 301, States are open to impose discriminatory and unreasonable taxes and therefore, States’ powers have to be curtailed.
  6. Section 297 of the Government of India Act, 1935 was first introduced to maintain economic unity in a scenario where States were given autonomy. Provisions such as Section 297 of the Government of India Act, 1935 and Article 301 and Article 304 of the Constitution have been inserted as checks and balances to ensure that while States have the power to tax and raise revenue for maintaining provincial autonomy, they do not impose taxes, which threaten economic unity and parity.
  7. A State may impose a non-discriminatory tax on goods coming from other States if similar goods are produced within the State under the provisions of Article 304 (a).5 However, if similar goods are not produced then issue of discrimination does not arise and States can tax such goods according to the provisions of Article 304 (b)
  8. The only manner in which Article 301, Article 304 and Entry 52 of List II of the Seventh Schedule to the Constitution of India (Entry 52) can be read together is that, only those taxes, which are reasonable and in public interest are permitted.
  9. In light of the provisions of Clauses (a) and (b) of Article 304, laws under the purview of Clause (a) have to satisfy the requirement of reasonableness in public interest as stipulated in Clause (b). The proviso to Clause (b) does not restrict autonomy of States, since there are ample instances wherein the Presidential assent has been easily granted. The proviso to Article 304 (b) is an important safeguard consciously added in the Constitution of India for the maintenance to economic unity of the nation6 which can be ensured by the Centre.7
  10. Entry Tax by nature is a direct impediment in trade under Article 301 and there is no compensatory aspect in such taxes as imposed by States currently. Entry Tax is imposed for the purposes of a local area and not for general revenue of the State.

Submissions of Mr. A.K. Ganguli, Senior Advocate

The Proviso to Article 304 (b) ensures that the President as the head of the federation ensures that State law that fetters free trade is a reasonable restriction in the public interest. The Proviso is inserted to maintain the economic unity and parity of the nation.

Mr. Bagaria, in addition to the submissions of Mr. Salve, made the following brief submissions:

  • Article 304 (a) applies only to goods imported from other States or Union Territories. Before levying tax on external goods Article 304 (a), the State Legislature has to levy a similar tax on internal goods and this can be so done only under Article 304 (b) and subject to fulfillment of all the three conditions of Article 304 (b), namely the tax being a reasonable restriction, its being required in the public interest and the Bill being introduced in the Legislature with the previous sanction of the President.
  • If tax on external goods is imposed under Article 304 (a) without levying a similar tax on internal goods under Article 304 (b), it will be a clear case of discrimination between external goods and internal goods. Article 304 (a) itself prohibits any such discrimination.
  • Non-discriminatory taxes and Entry Tax, if not satisfying the conditions of Article 304 (b), violates Article 301.

Submissions of Mr. A.K. Ganguli, Senior Advocate

Mr. Andhyarujina in his submissions emphasized that the questions that have to be addressed by the Bench are those referred in the referral order 16 April 2010.9 Specifically the significance of the word “and” as found between Clauses (a) and (b) of Article 304 and their relations needs to be discussed. Additionally, he made the following submissions:

  • Entry Tax by nature is a direct impediment in trade under Article 301 and there is no compensatory aspect in such taxes as imposed by States currently. Entry Tax is imposed for the purposes of a local area and not for general revenue of the State.
  • Clauses (a) and (b) of Article 304 must be read conjunctively; therefore, nondiscriminatory taxes have to be reasonable and in public interest.

Submissions by Mr. S.K. Bagaria, Senior Advocate

The Proviso to Article 304 (b) ensures that the President as the head of the federation ensures that State law that fetters free trade is a reasonable restriction in public interest. The Proviso is inserted to maintain the economic unity and parity of the nation.

Mr. Bagaria, in addition to the submissions of Mr. Salve, made the following brief submissions:

  • Article 304 (a) applies only to goods imported from other States or Union Territories. Before levying tax on external goods Article 304 (a), the State Legislature has to levy similar tax on internal goods and this can be so done only under Article 304 (b) and subject to fulfillment of all the three conditions of Article 304 (b), namely the tax being a reasonable restriction, its being required in the public interest and the Bill being introduced in the Legislature with the previous sanction of the President.
  • If tax on external goods is imposed under Article 304 (a) without levying a similar tax on internal goods under Article 304 (b), it will be a clear case of discrimination between external goods and internal goods. Article 304 (a) itself prohibits any such discrimination.
  • Non-discriminatory taxes and Entry Tax, if not satisfying the conditions of Article 304 (b), violates Article 301.

Submissions by Mr. Arvind P. Datar, Senior Advocate

Mr. Datar made his separate submissions on various issues arising in the matter. Following are his key submissions:

Compensatory Tax

  1. This test of compensatory tax allows States to bypass the provisions of Part XIII, which is not envisioned under the Constitutional Scheme.
  2. The concept of compensatory tax can be confined to only Entry No. 56 and 57 of List II, Schedule VII because it has been applied from 1962 to 199510 It
  3. Is the power to make laws and levy taxes reserved in favor of the States under Article 246 read with List-II subject to Part-XIII of the Constitution?
  4. In case answer to question No. 3 is in the negative, would any interpretation should not, however, be applied to any other tax/duty in the State List.
  5. Neither the “direct or immediate effect” test ofAtiabari nor the “working test” of Automobile Transport is feasible in practice. The proper test will be whether there is Appreciable Adverse Effect on Trade and Commerce (AAETFC for short). (This concept is borrowed from Section 3 of the Competition Act, 2002).
  6. The existence of AAETC can be determined in the way in which trade and commerce was carried out before the impugned law and the manner in which it is carried on after the impugned enactment. The adverse effect can be on the production or manufacture of goods, the supply of services, the impact on purchase or sale prices, the consequent geographical/environmental restrictions, etc. The AAETC may also involve consideration of the impact on consumers.
  7. The burden of proof will be on the petitioner to establish, prima facie, actual or potential AAETC. Thereafter, the state will have to establish that restrictions are reasonable and in public interest.
    Interpretation of Articles 301, 304(b) and 19(6)
  8. Article 301 should be read as “Subject to the [restrictions contained in the other] provisions of this Part…….”
    Restrictions contemplated in the Article 19(6) and 304(b) are dissimilar. Part III contains rights but Part XIII contains a series of injunctions/restrictions on Parliament and State Legislatures.
  9. Mr. Datar submitted that the word “and” can mean “and” as well as “or”. This is called a joint and several “and”. Therefore, Article 304(b) will also apply to exorbitant taxes and taxes/fees on export of goods.
    Tax laws consist of substantive and procedural provisions. A nondiscriminatory tax that does not violate Article 304(a) will still violate Article 304(b) if it has discriminatory procedural provisions.
    Entry Tax cannot be levied only on those goods coming from other States
  10. Mr. Datar submitted that Entry Tax, as imposed by the States currently, is wholly impermissible on account of the following reasons
  • If Entry Tax is levied on entry into a state border, it is ultra vires Entry 52 as well as Article 304(a). This has been upheld by the Arunachal Pradesh High Court, which is the subject matter of SLP (C) No. 13270-74 of 2009).
  • Levying Entry Tax to equalize difference in sales tax will be equivalent to levying a countervailing duty. This is permissible only in Entry 51 of List II.
  • Levy of Entry Tax results in expanding the taxing power of the state because the tax is sought to be levied on the entry of goods into the “State”. A state cannot expand its taxing power by giving artificial definitions to a word in a taxing entry. For example, defining “sale” to include works contract was held to be an impermissible expansion of Entry 54 of List-II as held in the case of State of Madras vs. Gannon Dunkerly & Co 11
  • Just as Octroi cannot be levied only on entry into a state, Entry Tax also cannot be so levied.

Impact of Goods & Service Tax (GST):

Against the backdrop of the GST Bill to be passed in the Parliament, Mr. Datar submitted that Article 304 (a) refers to only goods and not services. Under proposed Article 246A, each State can levy its own GST. Therefore, taxes on services by the GST imposed by the States will only be saved under Article 304 (b) considering that the Constitution (122nd Amendment) Bill, 2015 does not make any amendment to Article 304(a). During the course of arguments spread over six days the Bench has made numerous observations and placed many questions before the Bar. The key observations amongst them are as under:

  • Taxes simpliciter are not a restriction under Article 301, however, some taxes may attract the provisions of Part XIII of the Constitution of India
  • The theory of compensatory taxes being outside the purview of Article 301 as a judicially evolved concept cannot be followed as it goes against the scheme of the Constitution of India. Furthermore, as per this taxes would amount be fee and same is not acceptable under the Constitution
  • If the nexus theory view is accepted then the accounts of States would have to be scrutinized, which is a position not envisioned under the Constitution.
  • The Bench referred to Justice Sinha’s opinion in the Atiabari Tea Caseand held that if a tariff wall is erected as an impediment/barrier, it must be removed. However , the parameter/test for the same is not laid down
  • Entry 52 does not state that tax so collected is for the benefit of the local area.
  • States may be divested of their exclusive powers to legislate if Article 304 (b) applies to taxes.
  • That since all taxes are in public interest then there is no requirement of Article 304 (b) to apply to taxes.
  • If Article 304 (b) requires laws to be reasonable and in public interest then what is the need for the Proviso to Article 304 (b) requiring Presidential assent of such laws.

Submission of Union of India vis-à-vis the GST and its impact

During the hearing, the Ld. Attorney General, Mr. Rohatgi, submitted to the Bench that with the GST coming in the future, the question of Entry Tax will not arise as Entry 52will be repealed.