Tuesday, August 23, 2011

Retailers Assoc. v. Union: Bombay High Court on Service Tax

In a previous post, I had briefly mentioned the judgment of a Division Bench (D.Y. Chandrachud and  A.V.Mohta, JJ.) the Bombay High Court, where the constitutional validity of service tax on renting of immovable property was upheld. The judgment (Retailers Association v. Union of India) is available on the Bombay High Court website (linked here). A perusal of the judgment shows that three separate challenges were urged before the Court:
(i) The essence of a “service tax” is the rendering of a service or of a value addition, and in the case of renting of immovable property, no service element is involved; consequently, the charge must fail
(ii) The impugned levy fell under Entry 49, List II, and was outside the legislative competence of Parliament
(iii)  In any case, levying the tax retrospectively from 1st June 2007 was unconstitutional

After discussing the relevant Supreme Court decisions on the point, the High Court noted “the settled principle of law is that a tax on lands and buildings is a tax on the general ownership of lands and buildings. In order that a tax must fall under Entry 49 of List II, the tax must be one directly on lands and buildings. A tax which is levied on the income which is received from lands or buildings is not a tax on lands or buildings. A tax levied on an activity or service rendered on or in connection with lands and buildings does not fall within the description of a tax on lands and buildings.” The Court next examined the charging section, Section 66 of the Finance Act, 1994. It noted that the charge was on “taxable services”. Looking at the character of the impugned levy, it was held “The charge of tax is on a taxable service. The measure of tax is the gross amount charged by the service provider. The charge of tax is not on lands or buildings as a unit nor is the tax on lands or buildings. To be a tax on lands and buildings under Entry 49 of List II, the tax must be directly a tax on lands and buildings. That is not the true character of an impost on taxable services.” The measure of the tax may be the rental income; that does not mean that the nature of the tax is itself a tax on land.

Next, turning to the argument that there is no “service” involved in mere renting, the Court held that when Parliament legislates on a matter, it is open to Parliament to make assessments of fact on the basis of which a legislation can be drafted. Importantly – and perhaps, in a comment of wider constitutional significance – the Court held, “An underlying assessment of fact by Parliament on the basis of which a law has been enacted cannot be amenable to judicial review absent a case of manifest arbitrariness.” Apart from this, the Court noted that it is open to Parliament to enact deeming fictions as well. The only limitation on the exercise of the power is that the Legislature cannot by deeming fiction “transgress upon a constitutional restriction or a field of legislation that is reserved to another legislature.” Considering in this case that there was no transgression into List II, there was no question of there being any limitation on the power of Parliament to treat renting as a service. The Court explained, “Once the Court comes to the conclusion that the law is not a law with respect to the legislative entry of taxes on land and buildings, the field of the legislation would necessarily fall within List I and more particularly, the residuary entry of List I. The levy of tax on a taxable service provided or to be provided to any person, by any other person, by the renting of immovable property is based on a considered determination by Parliament that such transactions do in fact involve an element of service. The fact that the service which is provided may not, to the Petitioners, accord with what is commonly regarded as a service would not militate against the validity of the legislation.

Insofar as the challenge on the basis of retrospectivity is concerned, the Court noted the legislative history, by which it could fairly be said that the retrospective amendment was curative / validating, and intended to bring out the true intent of Parliament in enacting the Finance Act 2007. The amendment was intended to remove the basis of Delhi high Court’s the ruling in Home Retail, and was a permissible exercise of legislative power. (The test for judging the validity of such laws has been laid down by the Supreme Court in several cases – see this post, for a brief discussion. When compared to some other exercises of retrospective taxation, the impugned amendment in this case is quite benign!) 

The judgment of the Bombay High Court contains a careful analysis of the law in relation to all the three contentions; and the decision rests on a strong principled basis. The issue is pending in the Supreme Court in Home Retail, but it seems unlikely on the basis of the law as it currently stands that the Supreme Curt will take a different view.


Khagesh Gautam said...

A bunch of petitions on similar issue (service tax on renting of immovable property) was recently argued before the Punjab and Haryana High Court; the petitions were all dismissed. I am given to understand that some of the petitioners have approached the Supreme Court by filing SLPs. Arguments of similar nature were taken before the P&H High Court and they were all dismissed on the same grounds. Though the case could have been argued much much better. Actually all counsel in the case were convinced that the court would grant a stay as some others high courts had. Also, all lead counsel were not sure if the case would be argued because the counsel for Union of India had made a statement that the Union would be filing a transfer petition before the Supreme Court. Therefore I don't think any of the lead counsel were prepared the way they should have been prepared.

There is one point that I believe has not been considered in these cases. The first of these cases that I know is the Home Solutions Case (Delhi HC DB 2009) where the levies were struck down but on a technical point, and this point has not been raised or discussed in this case.

The point is this - a transaction of renting out movable property can not be deemed to be a transaction of service in absence of a constitutional permission to make such a deeming fiction. This is because in a renting transaction the owner of the property transfers his right to possess and enjoy the property in favour of the tenant for a consideration. The consideration (on which service tax is to be levied) represents a transaction where rights are transferred by one party to another. Such a transaction, legally, must be recorded on a legal document and must be appropriately stamped. This stamp duty is a tax that is paid and this tax can be imposed by State and not Central Legislature. Thus, the transaction is being taxed again (though there is no restriction against double taxation and thus this is a weak point). In any case, this is a transaction whereby rights are transferred and therefore the element of service can never be deemed in this case absent a constitutional provision (like in the case of a hire purchase and works contract transaction for sales tax).

I am of the view that this argument is supported by relevant case law but has never been argued. Or if it has been argued I seem to have missed it. I hope somebody argues this point before the Supreme Court though in practice the kind of tax bench that we have right now in the Supreme Court I would not keep my hopes up very much.

Mihir Naniwadekar said...

Thank you for the comment; I just had a couple of clarifications:

"Thus, the transaction is being taxed again (though there is no restriction against double taxation and thus this is a weak point). In any case, this is a transaction whereby rights are transferred and therefore the element of service can never be deemed in this case absent a constitutional provision (like in the case of a hire purchase and works contract transaction for sales tax)."

I am not sure if I understand this point correctly: are you saying that Parliament would not have the power to enact a deeming provision without a constitutional mandate to specifically say so? In hire-purchase situations, the reason why a deemed sale concept had to be brought in through constitutional amendment is that there would otherwise be a conflict with entries in List II. In the case of service tax, as the Court demonstrates, there is no such conflict. Where eould the restriction on the power to enact a deeming provision then come in?

Also, about the argument regarding double taxation: another possibility is that the two taxes may be of different natures, though the measure is the same. (Incidentally, the argument you make can also be applied to several deemed income provisions in the income tax act also)

Khagesh Gautam said...

If I recall correctly, there was a big conflict between central sales tax and local sales tax when it came to hire purchase and works contracts transactions. If we review the old case law (i.e. before 1980s) the courts had held that since no property passes when a works contract is executed, thus no sales takes place, sales tax cannot be charged on a works contract transaction. This created a very big problem for the states because of the constitutional prohibitions against a tax on sales - Parliament can only tax inter-state sales. And here we had the Supreme Court saying that there was no sales, let alone an inter-state sale in case of works contracts.

The issue was then discussed in Law Commission's 61st Report. And amendment was made in 1982 inserting Article 366 (29A) and defined what 'sales or purchase of goods' means for purpose of tax.

It was only after this amendment, that the constitution itself recognized, by a deeming fiction of law (there are several Supreme Court cases on this point), a certain transaction that in law is not recognized as sale, was recognized, for the specific purpose of imposing local sales tax, as a sales transaction.

The point here is like this - just because the constitution says a works contract transaction is sale transaction does not actually make it sale transaction and every body knows why. But for the purpose of sales tax it is allowed that the legislature treat this transaction as a sales transaction. It is a fiction and everyone knows it but a necessary one for otherwise as per Article 265 the tax would be void of any authority of law.

Based on this analogy, I had said, that if we have a transaction that clearly does not fall within the ambit of taxable transactions under a tax law, then unless there is a constitutional provision, giving express authority to tax that transaction (which of course can be done only by deeming that transaction, for the purpose of imposing tax, a taxable transaction) the same cannot be taxed for otherwise the tax will be without any authority of law.

In my opinion a transaction of renting out an immovable property is a transaction whereby rights in such property are transferred for consideration. In such a case, it is difficult to see the 'value addition' or an 'element of service' that is rendered. Now, of course, if there is a constitutional provision allowing the legislature to make a deeming fiction in that regard, the tax can be imposed but not otherwise since otherwise this transaction is simply not a transaction of service.

Honestly, I think the courts are bending over backwards to allow this tax. Every tax lawyer knows that all tax courts are heavily pro revenue.

Renganath said...

As Mihir has pointed out, the issue in Gannon(1)- 46th Amnd - Builder's Assoc. arose because List II used the word "sale" which the courts held had a specific connotation in law and therefore Parliament could not by a statutory exercise undo the constitutional (implied) definition.. Unfortunately here, the word "service" hasn't been used in the Constitution..