Can the operation of fiscal laws be interjected by a contract to the contrary? Can the parties to the contract stipulate respective covenants contrary to the legislative mandate flowing under a tax statute? What are the limits of Section 23 of the Contract Act which declares an agreement to be void if inter alia the consideration or objection of such agreement is “forbidden by law”, “would defeat the provisions of any law” or is “opposed to public policy”? These are similar other related questions arisen in respect of tax-related stipulations in modern commercial contracts which unabashedly provide for the respective tax obligations of the parties often at odd with the provisions of the taxing statutes. The answers manifest upon a careful calibration and exposition of the “party autonomy” principle which is increasingly been recognised by the courts as the basic standard of many legislations.1 This note attempts to briefly decipher the state of the legal position facing these issues.
“Taxable person”: An inviolable feature of taxing statute
The levy of tax in India is subject to it satisfying the constitutional stipulations2 which have been judicially interpreted to mean that a valid taxing statute must intrinsically exhibit with sufficient clarity certain components inter alia with “a clear indication of the person on whom the levy is imposed and who is obliged to pay the tax” being one such axiomatic component.3 Consequently, the identity of a person who is obliged to defray the tax under a particular taxing statute is well established. For illustration, under the income tax law the person whose income is subjected to tax is ordinarily the person liable to pay income tax, except where the law provides for representative assessment, etc.4 As another illustration, the Goods and Services Tax (GST) law affixes the liability of GST on the supplier, excepting those cases where the liability is upon the recipient of supply under the “reverse charge” mechanism.5 In short, in each situation, the tax statute invariably identifies the person who is obliged to interface with and comply with the provisions of such statute, so much so that in the absence of the taxing person identified in the fiscal statute the charge of the tax fails and there can be no recovery.6
The consequence of the aforesaid axiomatic position under the fiscal jurisprudence is that the liability under the tax statute is affixed on the person identified therein and does not fluctuate. This consequence being a facet of taxing statute, it would ordinarily imply that a legal eclipsing out not ordinarily ensue unless an exception exists to such effect within the statute. One such exception, for illustration, is under the income tax law which gives legal sanction to an arrangement where a person assumes the income tax obligation of another person.7 Another illustration, though outside the framework of the fiscal laws, is the law governing sale of goods which ordinarily permits the seller/supplier to pass on the incidence of any duty of customs or excise on goods or any tax on the sale or purchase of goods to the buyer/recipient.8
In view of the aforesaid legal position, a question arises on the scope and ability of a person to delegate or transfer a tax liability upon another person in the absence of a mechanism under the taxing statute itself.
Exploring the extant of “party autonomy”
The party autonomy principle is the derivation of the freedom of contract which extends to seemingly give complete independence to the parties to a contract to choose their respective bargains, subject obviously to the legal stipulations qua the ingredients of a valid contract. As described in Anson’s Law of Contract, one of the key expositions of the freedom of contract is “the freedom of a party to choose to enter into a contract on whatever terms it may consider advantageous to its interests, or to choose not to. Contractual obligation is thereby attributed to the will of the parties.”9
On this premise, courts are reluctant to interject the contractual covenants, even in instances where the Government is one of the contracting parties, on the alleged ground of “unconscionable bargain”10 except in situations at odds with the constitutional paradigm.11 Indeed, there are limitations on the freedom of contract doctrine, such as Section 23 of the Contract Act, in the context of which the Supreme Court has time and again delineated the limitations on the freedom of contract.12 However, the jurisprudence is clearly in favour of giving broader meaning and contours to the freedom of contract wherein parties are judicially recognised to act independently within the legislative framework governing the subject-matter of contract.13 On that count, perhaps not as an overstatement, even the recognition of arbitration awards is considered to be fundamentally based on party autonomy principle.14
It is in the aforesaid pedestal that the extent of party autonomy principle needs to be explored, in particular whether the limits of party autonomy extend to modifying the obligations under the taxing statutes.
Permitting contractual shifting of tax liability
The decision in Numaligarh Refinery Ltd. v. Daelim Industrial Co. Ltd.15 is one of the leading instances where the sale of goods law was invoked by the Supreme Court in an arbitration dispute to counter stance the submission that an increase in countervailing duty could not be passed on to the buyer. However, the Supreme Court held so only after recognising that the relevant statutory provision permitted the parties to agree to a different understanding in view of the usage of the expression “[u]nless a different intention appears from the terms of the contract” and, factually, such intention remained unsubstantiated before it.
The decision in Numaligarh Refinery16, however, is more pertinent to our inquiry in respect of the other proposition which it institutes, i.e. recognition of the “firm and fixed” price concept under the contract.17 The Supreme Court gave judicial sanction to the contention that where the parties have agreed to such price terms, no changes would be permitted on account of subsequent escalations. The decision in Numaligarh Refinery18 in this respect, however, was in the context of foreign exchange fluctuation and thus cannot be exactually said to be an authority for the proposition qua taxing statute. Its proposition was nonetheless extended to a tax situation in two subsequent decisions i.e. Sumitomo Heavy Industries Ltd. v. ONGC Ltd.19 and Rashtriya Ispat Nigam Ltd. v. Dewan Chand Ram Saran;20 the decision in Sumitomo21 being in context of income tax while the Rashtriya Ispat22 decision dealing with service tax liability. Both cases came up before the Supreme Court challenging the respective arbitration awards wherein the Supreme Court approved the scope of the party autonomy principle as extending to shift the tax liabilities. In fact, in Rashtriya Ispat23 the Supreme Court approved the argument that “it is conventional and accepted commercial practice to shift such liability to the contractor”.
In subsequent decisions, the proposition that the parties through contract can agree to shift the tax liability inter se themselves, has been given a consistent imprimatur by the Supreme Court.24 Thus, notwithstanding the unequivocal terms of the fiscal statutes identifying the person liable to pay the tax, the parties by way of a contract can agree to inter se shift the incidence of tax. Having said that, the concerned party cannot invoke such agreement before the taxing authority (before whom it continues to remain liable) and the contractual agreement is at best an ability for such party to seek indemnification from the counterparty. The resultant legal position has been explained by the Delhi High Court inter alia in the following terms:25
20. The above ruling of Supreme Court in Rashtriya Ispat Nigam Ltd., however, cannot detract from the fact that in terms of the statutory provisions it is the appellant which is to discharge the liability towards the Revenue on account of service tax. Undoubtedly, the service tax burden can be transferred by contractual arrangement to the other party. But, on account of such contractual arrangement, the assessee cannot ask the Revenue to recover the tax dues from a third party or wait for discharge of the liability by the assessee till it has recovered the amount from its contractors.
Thus, party autonomy has been given full play by the judiciary as regards ascertaining their inter se tax obligations with the limited caveat of the principle not interjecting the enforcement of the fiscal law provisions.
Extending party autonomy to other obligations under fiscal laws
Shifting of tax liability under the contract is not the only interface between the two laws. There are other aspects to it as well. Some of these aspects were recently examined by the Supreme Court in Bharat Forge.26 The obligations of tax law do not transcend to commercial realm; this is the clear dictum flowing from this decision. The facts of the case are not extraordinary. A public authority issued a proposal inviting tender from private parties for supply of goods. The parties were advised to separately quote the rate of tax (i.e. GST) they considered as applicable on the supply. The tender was subsequently awarded to a party which quoted GST@5%. This was challenged by another party which lost out because it claimed to have quoted GST@18%. The losing party challenged the action (rather inaction) of the public authority before the High Court, which accepted the challenge. The High Court opined that in order to ensure a level playing field between the private parties, the public authority was obliged to explain the technical attributes of the supply it had sought (i.e. HSN classification) and the applicable GST rate. Reversing the decision of the High Court, the Supreme Court in Bharat Forge27 inter alia observed as under:
40. The liability to pay tax under the GST regime is on the supplier. He must make inquires and make an informed decision as to what would be the relevant HSN Code applicable to the items and the rate of tax applicable. Thereafter, when he makes the bid, the issue of competition for winning the bid, would come into clear focus. The goal of the bidder ordinarily is to emerge successful and bag the contract. The extent of profit that he would earn, is a matter, which is essentially a matter to be decided by him. He may, for germane reasons, wish to bag a contract, with situations ranging from one extreme end of the spectrum viz. even when the prospect of a loss stares at him, or a slightly brighter outcome viz. the contract working on a break-even basis or moving on to an even more optimistic possibility, namely, of the contract earning him profit, which he is willing to take at a modest rate or a rate which he considers as reasonable in his understanding and circumstances. This is a matter to be left to the commercial expediency of the bidder.
Explaining the limited scope of judicial review by High Court in such contractual aspects, the Supreme Court has clearly opined therein that neither the inter se tax obligations of parties can be brought within the confines of a contractual disputes nor will the courts entertain such disputes which are matter of commercial expediency of the parties.
The aforesaid discussion clearly brings to fore two fundamental propositions; (a) the application of tax laws and the obligations therein qua the taxable person identified therein cannot be interjected by way of a contract; (b) the proposition in (a), however, does not restrain the parties to a contract to shift the incidence of tax and other tax compliance. There is sufficient judicial authority for the legal position that the proposition in (b) does not come at odds with “public policy” or other limitations on freedom of contract, thereby the party autonomy principle permits the parties to dehyphenate tax from contractual realm.
† Tarun Jain, Advocate, Supreme Court of India; LLM (Taxation), London School of Economics
1. For illustration, see Amazon.Com NV Investment Holdings LLC v. Future Retail Ltd., (2022) 1 SCC 209, inter alia declaring that party autonomy is “one of the pillars of arbitration” in the Arbitration and Conciliation Act, 1996.
3. Govind Saran Ganga Saran v. CST, 1985 Supp SCC 205. The decision inter alia observes: “[t]he components which enter into the concept of a tax are well known. The first is the character of the imposition known by its nature which prescribes the taxable event attracting the levy, the second is a clear indication of the person on whom the levy is imposed and who is obliged to pay the tax, the third is the rate at which the tax is imposed, and the fourth is the measure or value to which the rate will be applied for computing the tax liability. If those components are not clearly and ascertainable, it is difficult to say that the levy exists in point of law. Any uncertainty or vagueness ill the legislative scheme defining any of those components of the levy will be fatal to its validity.”
9. Anson’ s Law of Contract, 27th Edn., p. 4. Also, quoting Lord Diplock in Photo Production Ltd. v. Securicor Transport Ltd., (1980) AC 827: (1980) 2 WLR 283, it is opined that “a basic principle of the common law of contract … is that the parties are free to determine for themselves what primary obligations they will accept”.
12. For a recent legal exposition, see PASL Wind Solutions (P) Ltd. v. GE Power Conversion India (P) Ltd., (2021) 7 SCC 1 inter alia summarising the legal position in Gherulal Parakh v. Mahadeodas Maiya, AIR 1959 SC 781; Murlidhar Aggarwal v. State of U.P., (1974) 2 SCC 472; Union of India v. Gopal Chandra Misra, (1978) 2 SCC 301; Central Inland Water Transport Corpn. Ltd. v. Brojo Nath Ganguly, (1986) 3 SCC 156; Rattan Chand Hira Chand v. Askar Nawaz Jung, (1991) 3 SCC 67; Renusagar Power Co. Ltd. v. General Electric Co., (1994) Supp (1) SCC 644.
14. See generally, Markfed Vanaspati & Allied Industries v. Union of India, (2007) 7 SCC 679 quoting Russell on Arbitration to the following effect; “Russell on Arbitration, 19th Edn. at pp. 110-11 described the entire genesis of arbitration as under: ‘An arbitrator is neither more nor less than a private Judge of a private court (called an Arbitral Tribunal) who gives a private judgment (called an award). He is a Judge in that a dispute is submitted to him; he is not a mere investigator but a person before whom material is placed by the parties, being either or both of evidence and submissions; he gives a decision in accordance with his duty to hold the scales fairly between the disputants in accordance with some recognised system of law and rules of natural justice. He is private insofar as (1) he is chosen and paid by the disputants (2) he does not sit in public (3) he acts in accordance with privately chosen procedure so far as that is not repugnant to public policy (4) so far as the law allows he is set up to the exclusion of the State courts (5) his authority and powers are only whatsoever he is given by the disputants’ agreement (6) the effectiveness of his powers derives wholly from the private law of contract and accordingly the nature and exercise of those powers must not be contrary to the proper law of the contract or the public policy of England bearing in mind that the paramount public policy is that freedom of contract is not lightly to be interfered with.’ Whatever has been mentioned by Russell in this paragraph is equally true for Indian arbitrators.” (emphasis supplied)
25. Delhi Transport Corporation v. Commissioner Service Tax, 2015 SCC OnLine Del 8786 The petition for special leave against this decision stands dismissed vide order dated 15-1-2016 in SLP(CC) 284 of 2016.