The Constitution of India empowers the States to levy various classes of taxes within their territorial confines.1 Simultaneously, the Constitution stipulates for freedom of trade, commerce and intercourse throughout the territory of the country.2 What if a State tax inhibits this freedom? This question has been a bone of contention and judicial seesaw in India for very long, largely in the context of “entry taxes”.3
The Supreme Court in early 1960s concluded that certain States taxes simplicitor did interject with the freedom; its levy being permitted subject to satisfaction of the “compensatory tax” test. In Atiabari Tea Co. Ltd. v. State of Assam4 a 5-Judge Bench of the Supreme Court examined correctness of Assam Taxation (on Goods Carried by Roads or Inland Waterways) Act, 1961 and subsequently in Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan5 a 7-Judge Bench of the Supreme Court examined the issue in the context of Rajasthan Motor Vehicles Taxation Act, 1951. Speaking for the majority in Automobile Transport case6, Das, J. concluded the legal position in the following terms:
“14. After carefully considering the arguments advanced before us we have come to the conclusion that the narrow interpretation canvassed for on behalf of the majority of the States cannot be accepted, namely, that the relevant articles in Part XIII apply only to legislation in respect of the entries relating to trade and commerce in any of the lists of the Seventh Schedule. But we must advert here to one exception which we have already indicated in an earlier part of this judgment. Such regulatory measures as do not impede the freedom of trade, commerce and intercourse and compensatory taxes for the use of trading facilities are not hit by the freedom declared by Article 301. They are excluded from the purview of the provisions of Part XIII of the Constitution for the simple reason that they do not hamper trade, commerce and intercourse but rather facilitate them.
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17. We have, therefore, come to the conclusion that neither the widest interpretation nor the narrow interpretations canvassed before us are acceptable. The interpretation which was accepted by the majority in Atiabari Tea Co. case7 is correct, but subject to this clarification. Regulatory measures or measures imposing compensatory taxes for the use of trading facilities do not come within the purview of the restrictions contemplated by Article 301 and such measures need not comply with the requirements of the proviso to Article 304(b) of the Constitution.”
This legal position continued for decades with various decisions of the Supreme Court qualifying the compensatory tax test and sharpening its contours.8
The judicial doctrines and varying legal propositions were streamlined and the conceptual nuances of compensatory taxes were clarified by a 5-Judge Bench of the Supreme Court in 2006 in Jindal Stainless Ltd. (2) v. State of Haryana.9 It is ironical that it was in this decision that the judicial disposition on what constitutes compensatory taxes was delineated perhaps for the first time with categorical hue, inter alia with the following description of the compensatory taxes:
“45. To sum up, the basis of every levy is the controlling factor. In the case of ‘a tax’, the levy is a part of common burden based on the principle of ability or capacity to pay. In the case of ‘a fee’, the basis is the special benefit to the payer (individual as such) based on the principle of equivalence. When the tax is imposed as a part of regulation or as a part of regulatory measure, its basis shifts from the concept of ‘burden’ to the concept of measurable/quantifiable benefit and then it becomes ‘a compensatory tax’ and its payment is then not for revenue but as reimbursement/recompense to the service/facility provider. It is then a tax on recompense. Compensatory tax is by nature hybrid but it is more closer to fees than to tax as both fees and compensatory taxes are based on the principle of equivalence and on the basis of reimbursement/recompense. If the impugned law chooses an activity like trade and commerce as the criterion of its operation and if the effect of the operation of the enactment is to impede trade and commerce then Article 301 is violated.”
Within a few years of this descriptive canonisation of compensatory taxes in India, the Supreme Court again occasioned a revisit, this time to the very propriety and acceptability of the compensatory tax theory. This resulted into a 2-Judge Bench of the Supreme Court enlisting ten questions requiring a deeper resolve, including whether “the principles of quid pro quo relevant to a fee apply in a matter of taxes”.10 Seized of these issues and unable to address the conundrum11 a 5-Judge Bench of the Supreme Court referred the determination to a much larger Bench.12
The final determination
It was exactly a decade after the 5-Judge Bench of the Supreme Court in Jindal Stainless case13 had pronounced on the continued application of the compensatory tax test that a 9-Judge Bench of the Supreme Court in a case with similar cause title reversed the tide by withdrawing the legitimacy of compensatory taxes. In 2016 in Jindal Stainless case14 a 9 Judges of the Supreme Court, albeit by majority, concluded that levy of entry taxes was not an affront to the constitutional stipulation of freedom of trade, commerce and intercourse. More critically, this decision, by the largest Bench of the Supreme Court so far on the subject, categorically concluded that there was no constitutional basis for incorporation and sustenance of the compensatory tax test. The judgment ascribed entry taxes, similar to any other tax, as an “attribute of sovereignty” and thus concluded that were no fetters on the levy of entry taxes by the States, the court having invoked the principle that “constitutional limitations must be express” and judicially evolved concepts could not interject with constitutional empowerment of the States to levy taxes. The decision inter alia exuded the following legal reasoning to deprive the sanction to compensatory taxes: 15
“67. Three distinct aspects touching the question need be noticed straightaway:
The first and the foremost of these aspects is that the concept of compensatory taxes is not recognised by the Constitution. A tax is a compulsory exaction of money for general public good … If taxes are eventually meant to serve larger public good and for running the governmental machinery and providing to the people the facilities essential for civilised living, there is no question of a tax being non-compensatory in character in the broader sense. Secondly, because the concept of compensatory tax obliterates the distinction between a tax and a fee. The essential difference between a tax and a fee is that while a tax has no element of quid pro quo, a fee without that element cannot be validly levied. The difference between a tax and the fee has been examined and elaborated in a long line of decisions of this Court. Thirdly, and lastly, the concept of compensatory taxes being outside Part XIII, is difficult to apply in actual practice. Experience in the present batch of cases has amply demonstrated that difficulty. Most of the legislations enacted by the States in these cases have described the entry tax levied under the same to be compensatory in character. This may have been done to take the levy outside the mischief of Article 301 of the Constitution. The question however is whether tax amount collected in terms of the said legislation is really used by the State for the purpose of providing or maintaining services and benefits to the taxpayers and whether the courts can follow the money trail to determine whether the State concerned has actually used the amount for the avowed purpose underlying the legislation. This process is fraught with serious difficulties, a fact that was not disputed by the learned counsel for the assessees/dealers. Actual application of the compensatory tax theory, therefore, runs into difficulties to an extent that the theory at some stage breaks down. M/s Salve, Rohatgi and Dwivedi were in that view perfectly justified in submitting that the compensatory tax theory was legally unsupportable and deserved to be abandoned. We have no hesitation in agreeing with that submission, the arguments of M/s Ganguly and Bagaria to the contrary notwithstanding.”
This 9-Judge Bench decision16 was considered as a death knell for the compensatory tax test, the decision having revisited and reaffirmed the conceptual background and differences between “tax” as distinct from a “fee” and the ratio of the decision having been applied unwaveringly since.17
The debate reignited
It appears, however, that the tranquillity of legal position has been short lived. Called upon to examine the validity of a “road tax”18 levied by the State, a 3-Judge Bench of the Supreme Court in a recent decision in State of H.P. v. Goel Bus Service19 has reinvoked and reapplied the compensatory tax test as one of the yardsticks to affirm the levy.
Relying upon its earlier decisions (albeit all prior to the 9-Judge Bench decision),20 the Supreme Court in Goel Bus case21 upheld the road tax levy concluding it to be in the nature of a compensatory and regulatory tax inter alia observing as under:
“32. At the cost of repetition, it is stated that the appellant State being a hilly State, the roads and bridges are its lifeline. The State has to allocate sizeable part of its budget for the construction, development, repair, upkeep and maintenance of roads and bridges. It was with this object in the background that the offending provisions were brought in by way of amendments in 1999 and 2001 which are described as special road tax.
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36. From the very object and reasons of the amending Act, 1999, it is apparent that the special road tax was introduced as a compensatory measure. The object and reasons as spelled out in the original bill.…
37. What is to be seen is whether the tax imposed will have identifiable object and a nexus between the subject and the object of the levy. The power has been given to the States to make its own legislations by imposing tax on motor vehicles as also the goods being transported in order to compensate itself for the services, benefits and facilities provided by it.
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45. The objects and reasons for bringing in the 1999 Amendment was clearly compensatory in nature. The object was to augment funds and finance for construction, maintenance, repair and upkeep of the roads in the State of Himachal Pradesh which has a totally hilly terrain. …
46. Imposition of such additional special road tax was only to keep a check or a discipline on the transport vehicle operators to use their vehicles in accordance with the statutory provisions. This could work as a deterrent for the transport operators to not commit any breach and to follow the mandate of the law. Such additional special road tax could be termed as regulatory in nature so as to regulate other statutory provisions being implemented and strictly followed.”
For the aforesaid reasons, having concluded that the levy could be justified as a compensatory tax, the 3-Judge Bench22 reversed the decision of the High Court which had quashed it declaring to be ultra vires the power of the State Legislature.
That tax is a compulsory exaction and that there is no equity in taxation are well settled and axiomatic propositions underlying the canons of fiscal system. In this background, therefore, it is hardly surprising that the validity of a tax often receives a frontal attack from the taxpayers seeking relief from the scourge of taxation. Judicial indulgence and benevolence through evolution and application of novel concepts, while (incidentally) bringing respite to the taxpayers, result into muddling of legal concepts as the origin, growth and demise of compensatory tax saga reveals. Given the fact that the Supreme Court grappled with compensatory taxes for half a century to ultimately discontinue its application as being without a constitutional or legal sanction, one would have thought that the dust was settled once and for all with the 9-Judge Bench decision in Jindal Stainless case23. As the recent decision in Goel Bus case24 reveals, perhaps it may not be the case.
What is ironical is the fact that the application of compensatory tax test arose in context of road and motor vehicle taxes in Atiabari Tea case25 and in Automobile Transport case26 to be later applied to entry taxes, which was injuncted altogether in Jindal Stainless case27. The decision in Goel Bus case28 also deals with road taxes and hence it was perhaps a plain vanilla application of the ratio flowing from the 9-Judge Bench decision29. However, it is surprising that there is not even a reference in Goel Bus case30 to the decision in Jindal Stainless case31. At this stage it is premature to conclude whether the Goel Bus case32 decision is per incuriam on this account and would thus be denuded of its precedential value33 but certainly the decision reveals that compensatory tax test has arisen again, akin to a phoenix, to engage itself in yet another round of judicial course.
† Advocate, Supreme Court of India; LLM (Taxation), London School of Economics.
3. Earlier levied under Entry 52 of List II, Seventh Schedule which provided for “taxes on the entry of goods into a local area for consumption, use or sale therein”. The entry has been omitted by the Constitution (One Hundred and First Amendment) Act, 2016 seeking to subsume entry taxes within goods and services tax which levied under Article 246-A of the Constitution of India.
8. For illustration, see Madar Saheb v. State of A.P., (1972) 4 SCC 635 (5 Judges) opining upon its compensatory nature and upholding the levy of tax under the Andhra Pradesh Motor Vehicles Taxation Act, 1963 upon evaluation of data and figures under the government budget. See generally, Bhagatram Rajeevkumar v. CST, 1995 Supp (1) SCC 673; State of Bihar v. Bihar Chamber of Commerce, (1996) 9 SCC 136.
11. The order referring the issue to a larger Bench inter alia notes as under:
“5. The question, therefore, which we need to answer, in the first instance, before going into the validity of each of the State laws impugned before us is—whether after 49 years, this Court should revisit the tests propounded in the earlier decisions in Atiabari Tea Co. Ltd., AIR 1961 SC 232 and Automobile Transport (Rajasthan) Ltd., AIR 1962 SC 1406? At this stage, it may be mentioned that the States whose entry tax laws have been challenged have contended before us that the tests propounded in Atiabari Tea Co. Ltd., AIR 1961 SC 232 and Automobile Transport (Rajasthan) Ltd., AIR 1962 SC 1406 have failed to strike a balance between the ‘freedom of trade and commerce’ under Article 301 of the Constitution and the States’ authority to levy taxes under Articles 245 and 246 of the Constitution read with the appropriate legislative entries in the Seventh Schedule to the Constitution of India. The States, therefore, sought revisiting of the aforestated two decisions in Atiabari Tea Co. Ltd., AIR 1961 SC 232 and Automobile Transport (Rajasthan) Ltd., AIR 1962 SC 1406 by a larger Bench.” [Jindal Stainless Ltd. v. State of Haryana, (2010) 4 SCC 595]
17. For illustration, see State of Kerala v. William Fernandez, (2021) 11 SCC 705; Bharti Airtel Ltd. v. State of Orissa, (2021) 11 SCC 776; Jaiprakash Associates Ltd. v. State of M.P., (2018) 16 SCC 732; Indian Oil Corpn. Ltd. v. State of U.P., (2019) 16 SCC 482; State of Uttarakhand v. Kumaon Stone Crusher, (2018) 14 SCC 537.
18. Entry 56 List II Seventh Schedule (“taxes on goods and passengers carried by road or on inland waterways”), Entry 57 List II Seventh Schedule (“taxes on vehicles, whether mechanically propelled or not, suitable for use on roads, including tram cars …”).
33. See generally, Punjab Land Development and Reclamation Corpn. Ltd. v. Labour Court, (1990) 3 SCC 682 inter alia observing that “[t]he Latin expression per incuriam means through inadvertence. A decision can be said generally to be given per incuriam when this Court has acted in ignorance of a previous decision of its own or when a High Court has acted in ignorance of a decision of this Court. It cannot be doubted that Article 141 embodies, as a rule of law, the doctrine of precedents on which our judicial system is based.…”