The question is deceptively narrow but constitutionally deep: when a State has validly taxed a sale, can it levy a further charge, a surcharge, an additional tax, a cess, computed on that tax? Or does a levy pegged to a dealer’s turnover cease to be a tax on the sale of goods, which the State may impose, and become, in substance, a tax on income, which only the Union may impose? Three decades of conflicting precedent, a five-judge Bench one way, a seven-judge Bench another, brought the reference to a seven-judge Bench, which has now begun to hear it, even as the Centre suggests that the arrival of GST in 2017 has left the questions largely academic.
New Delhi: A seven-judge Constitution Bench of the Supreme Court has commenced hearing a long-pending reference on the legislative competence of State legislatures to impose a surcharge, additional tax, levy or cess calculated on the basis of a validly levied sales or purchase tax [Arjun Flour Mills v. State of Odisha].
The Bench comprises Chief Justice of India Surya Kant, Justice K.V. Viswanathan, Justice S.V.N. Bhatti, Justice Joymalya Bagchi, Justice N.V. Anjaria, Justice V. Mohana and Justice Arun Palli.
The question referred
The reference arises from a challenge to Section 5A of the Odisha Sales Tax Act, 1947, inserted in 1997, which prescribed an additional tax of 10% for dealers with an annual turnover between Rs 10 lakh and Rs 1 crore, and 15% where the turnover exceeded Rs 1 crore. The core question, as framed, is whether the imposition of a surcharge, additional tax, levy or cess on sale or purchase, calculated on the basis of a validly levied sales or purchase tax, is beyond the competence of the State legislature, that is, whether such a levy, computed with reference to a dealer’s annual turnover, falls outside Entry 54 of the State List and encroaches upon Entry 82 of the Union List, which concerns taxes on income.
The conflicting precedents
The reference was necessitated by a divergence in earlier decisions. In Hoechst Pharmaceuticals Ltd. v. State of Bihar, the Supreme Court had upheld a surcharge under the Bihar Finance Act as a sales tax falling within Entry 54 of the State List. The petitioner in Arjun Flour Mills contended that Hoechst had proceeded on a concession that the levy was relatable to Entry 54, and relied on the seven-judge Bench decision in India Cement Ltd. v. State of Tamil Nadu, which had struck down a cess and surcharge connected with mining royalty on the ground that a State cannot legislate outside the field assigned to it under the Seventh Schedule. Against these stood S. Kodar v. State of Kerala, in which a five-judge Bench had upheld an additional sales tax under the Tamil Nadu Additional Sales Tax Act, 1970, rejecting the contention that the levy was, in truth, a tax on income. Faced with this divergence, the Court referred the matter in 1999 to a larger Bench.
The submissions, and the Bench’s early views
Opening the hearing, Solicitor General Tushar Mehta submitted that there was broad consensus among the parties on the scope of the reference, and that the Court could proceed on the basis of the reference order itself without extensive further hearing. He also flagged the practical significance of the questions after the introduction of the Goods and Services Tax in 2017, submitting that with the change in the tax regime the questions may have become largely academic, with perhaps only a small number of cases still pending. On India Cement, he noted that the Centre had reservations about its correctness, that it had been the subject of a nine-judge Bench judgment and stood overruled, and that a curative petition had been filed, though he clarified that the Centre did not wish to press this in the present proceedings.
The Chief Justice indicated the Bench’s provisional sense of the precedents, observing that India Cement is no longer good law, that Kodar has been quoted with approval, and that the measure of tax liability is not the only dominant factor for determining the nature of a tax:
“India Cement is no longer a good law. Kodar has been quoted with approval, and the measure of tax liability is not the only dominant factor for determining the nature of a tax.”
The CJI added that the Bench would examine Kodar with an open mind, while noting that it too had received the imprimatur of a nine-judge Bench, albeit in a different context, and reference was made to Mineral Area Development Authority v. Steel Authority of India for the proposition that royalty does not include a tax. When counsel on the other side submitted that Kodar had been doubted only in the context of its potential conflict with India Cement, and that the principle was that an authority with the power to tax has the power to tax additionally, Justice Bagchi responded that legislative competence is to be decided on the basis of the nature of the tax, and not on the basis of the additional tax, an observation on which counsel expressed reservations.
The Chief Justice also indicated that a connected matter concerning Punjab would have to be segregated, as it raised a distinct question of legislative competence: where the Punjab Social Security Act had been upheld by the High Court, and a subsequent legislation displaced an earlier executive action, the question would arise whether that law could be struck down on the basis of the earlier executive action, the Court observing that there cannot be an estoppel against law.
Why it matters
At the heart of the reference lies a recurring problem of Indian fiscal federalism: how to characterise a levy for the purpose of allocating it between the Union and the States. The Constitution distributes taxing powers through distinct entries, the States may tax the sale of goods under Entry 54, while taxes on income fall to the Union under Entry 82, and a levy must be traced to a specific entry within the competence of the legislature that imposes it. The difficulty arises because an “additional” tax or surcharge computed on a sales tax, or geared to a dealer’s turnover, can be argued either way: as merely an enhanced tax on the same taxable event, the sale, or as a tax whose real subject is the dealer’s income or turnover, which the State cannot reach.
The doctrinal tools the Bench flagged are familiar to constitutional tax law but notoriously slippery in application. The nature of a tax is determined by its true character, its subject and its taxable event, and not merely by the measure used to compute it; a tax on the sale of goods does not become a tax on income simply because it is calculated with reference to turnover. The Chief Justice’s observation that the measure of tax is not the only dominant factor points to exactly this distinction between the object of a tax and its yardstick, and Justice Bagchi’s remark that competence turns on the nature of the tax, not on its being “additional”, presses the same point: the label does not decide the entry.
The Centre’s submission that the questions are largely academic after GST is significant but not dispositive. The Goods and Services Tax has, from 2017, subsumed most of the indirect-tax field that these levies occupied, so the practical stakes for future levies are diminished; but the reference must still resolve the correctness of the competing precedents for the cases that remain, and for the coherence of the law on the distribution of taxing powers, which retains relevance beyond sales tax. Nothing has been decided; the Bench has begun with an open mind, indicated its preliminary reading of India Cement and Kodar, and will hear the matter further, with the Punjab question set to be considered separately.
Case Title: Arjun Flour Mills v. State of Odisha [Civil Appeal No. 8763 of 1994]
Bench: Chief Justice of India Surya Kant, Justice K.V. Viswanathan, Justice S.V.N. Bhatti, Justice Joymalya Bagchi, Justice N.V. Anjaria, Justice V. Mohana and Justice Arun Palli, Supreme Court of India
Appearance: Solicitor General Tushar Mehta
Status: Seven-judge Constitution Bench reference; hearing commenced. Question of the State’s competence to levy a surcharge/additional tax calculated on sales tax under Entry 54 vis-a-vis Entry 82. Nothing decided; hearing to continue, connected Punjab matter to be segregated.