VIA NLSIR: Best Essays of the 7th Nani Palkhivala Foundation Taxation Law Essay Competition [# 3 by Dwaipayan Banerjee]

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Nani Palkhivala

The 7th Nani Palkhivala Foundation Taxation Law Essay Competition, 2014 was organised by the National Law School of India Review (NLSIR), the flagship journal of the National Law School of India University, Bangalore.

The results of this prestigious legal essay competition were declared a few days back.

We requested NLSIR and the authors to share the prize winning entries with us so that the essays could be made available for a wider audience. They are sweet chaps and they agreed. A big shout out to all the authors and the people at NLSIR!

Here’s the essay by Dwaipayan Banerjee which won the 3rd prize.

Can Aspect Theory justify overlapping of Central and State Taxes: A Critical Overview by Dwaipayan Banerjee

 The domain of substantive law has a close-knit relationship with almost every aspect of the human society. The principles, theories and precedents enunciated by courts concerning aspects of human society as expressed through the judicial decisions, are not by any means insignificant in their import on the destiny of human-kind.

In adjudicating the conflicting claims, courts frequently reveal of the legal concepts about the structure and basic foundation of our society, which have probably had as great a formative influence on our social institutions as that exerted by the non-legal specialists in the fields involved. Legal lore is rich in concepts concerning all aspects of our society. Such concepts, however, when involved in court decisions, may find their justification not in the social or economic realities, but in the principles of narrower field of jurisprudence.

A State must secure money for its maintenance. The power to make compulsory levies on its citizens for its support is inherent and is almost customary in the sovereignty of States. Such power is legislative and is limited only by the Constitutional prohibitions. Legislatures pass tax laws which, in lieu, helps the government in allocating the costs to provide for the constituent elements of the population in whose welfare the government is concerned.

This may probably be one of the earliest principles of levying of taxes which followed from a payment for services received by the tax payer from his government or overlord. The payment and services made by a vassal to his overlord for protection in the feudal society of middle ages can be explained on such a theory. This system broke down with the feudal society, although somewhat of a counterpart still remains in the system as fee is charged by the governmental agencies for special services.

Different statutes and judicial decisions have given expression to some of the concepts of taxation and of one such is the Aspect Theory, and it is the purpose of this essay to examine and justify the same!

To understand, the concept of taxation and to know what exactly is taxable, plays a very pivotal role. After the Indian Independence, the Constitution of India came into being under which certain amendments were made by the Constitution (Sixth Amendment) Act, 1956 whereby;

1. Taxes on sales or purchase of goods in the course of inter-State trade or commerce were brought expressly within the purview of the legislative jurisdiction of Parliament;

2. Restrictions could be imposed on the powers of State legislatures with respect to the levy of taxes on the sale or purchase of goods within the State where the goods are of special importance in the inter-State trade or commerce.

This amendment also authorised the Parliament to formulate principles for determining when a sale or purchase takes place in the course of inter-State trade r commerce or in the course of export or import or outside a State.

All of this was necessitated because India was newly independent and to develop the country’s infrastructure, law and public order, protection of property, public works, social engineering, etc., imposition of tax on the individuals gathers the most revenue for such works.

Taxes in India are levied mainly by the Central and State Governments. Apart from these, there are other taxes which are levied by the local authorities like the Municipality. This authority to levy a tax is derived from the Constitution of India whereby the power to levy taxes between various agencies of the Centre and State is allocated. Article 265 of the Constitution of India acts as a restriction and thus, states that “No tax shall be levied or collected except by the authority of law.” Thus, the taxes levied and collected by the authority is backed by an accompanying law, passed either by the Parliament or the respective State Legislature.

Article 246 distributes legislative powers including powers of taxation between the Central and State Legislature. The SeventhSchedule enumerates the subject matters of taxation using these three lists:

1. List I – entailing the areas on which only the parliament is competent to make laws,
2. List II – entailing the areas on which only the state legislature can make laws, and
3. List III – listing the areas on which both the Parliament and the State Legislature can make laws upon concurrently.

To enable the Parliament to formulate by law, principles for determining the modalities of levying the service tax, a new Article 268A was inserted for service tax levy by Union Government and also its collection and appropriation by the Union Government. As an amendment to Schedule VII of the Constitution, in List I (Union List) after entry 92B, entry 92C was inserted for taxes on services.

Entry 60 of List II of the Constitution of India states that “taxes as professions, trade, callings and employment”. Entry 60 is a taxing entry, and is not a general entry. Tax on professions etc., has to be read as a levy on the professions, trade, callings, etc. Therefore, entry 60 which refers to professions cannot be extended to include services. This is what is called an “aspect theory”[1]

Now what is this “Aspect Theory”?

Any subject which is one aspect and one purpose fall within a particular legislature may, in another aspect and for another purpose fall within another legislative power. They might be overlapping, but that should be in accordance with the law. Same transaction may involve two or more taxable events in its different aspects, but the fact that there is overlapping does not detract it from distinctiveness of aspects[2].

The Supreme Court in the case of Shilpa Color Lab examined the aspect theory in the light of the landmark decision in the State of Madras v. Gannon Dunkerly & Co. Ltd. and held that the aspect theory would not apply to enable value of services to be included in the sale of goods or price of goods in the value of services.

It was also held in the same case that, the Service Tax is a levy on the service element and, therefore, any attempt to charge service tax on cost of materials would amount to taxing the goods, which is a subject-matter of State levy under the Sales Tax Law or VAT Law, as the case may be.

In another case[3], the levy considered was expenditure tax under Central Law with reference to the contention that the same was in substance tax on luxury under Entry 62 of List II. Stand of the Central Government was that expenditure aspect was different from luxury aspect. The plea was upheld and was observed that – “26… Wherever legislative powers are distributed between the Union and the States, situations may arise where the two legislative fields might apparently overlap.

It is the duty of the courts, however difficult it may be, to ascertain to what degree and to what extent, the authority to deal with matters falling within these classes of subjects exists in each Legislature and to define, in the particular case before them, the limits of the respective powers. It could not have been the intention that a conflict should exist; and, in order to prevent such a result the two provisions must be read together, and the language of one interpreted, and, where necessary modified by that of the other.”

In the case of Bharat Sanchar Nigam Ltd. v. Union of India[4], while deciding that there can be a simultaneous levy of two or more taxes on the same transaction, the Apex Court has also observed that the same transaction may involve two or more taxable events in its different aspects! 

In other words, though there can be a simultaneous levy of two different taxes, namely, sales tax and service tax, on the same transaction, they shall be on different components such as sales tax on the “goods” component and service tax on the “service” component! This has been further reinforced by the Apex Court in the same decision, wherein, it has observed as:

This does not however allow State to entrench upon the Union List and tax services by including the cost of such service in the value of the goods. Even in those composite contracts which are by legal fiction deemed to be divisible under Article 366 (29A), the value of the goods involved in the execution of the whole transaction cannot be assessed to sales tax.

For the same reason the Centre cannot include the value of SIM cards, if they are found ultimately to be goods, in the cost of the service.”

Further, in this far-reaching judgement, the Apex court, while framing various questions has, inter-alia, also framed an interesting question as under:

“Would the “aspect theory” be applicable to the transaction enabling the States to levy sales tax on the same transaction in respect of which the Union Government levies service tax?”

After addressing all the issues with finesse, the Apex Court observed that,

“The aspect theory would not apply to enable the value of the services to be included in the sale of goods or the price of goods in the value of the service.” 

This proposition makes it clear that, though there may be an overlapping of levy in a single transaction, but there cannot be an overlap in the value of such taxable events.

In the case of Gujarat Ambuja Cements Ltd. v. Union of India[5], the Supreme Court has held that,

“This mutual exclusivity which has been reflected in Article 246(1) means that taxing entries must be construed so as to maintain exclusivity.”

Putting it limpidly, if in a composite transaction like Works contract, where there is an existence of both “goods” as well as “services”, there can be a levy of both sales tax as well as service tax but the value for the sales tax shall be the former minus the value of the service component and vice versa. In other words, if the value for the sales tax and service tax are added up, they cannot exceed the total value of the transaction.

Be it the State which levies the sales tax on a composite contract as per Art 366(29A) or the Centre which levies the service tax on such composite contracts as per Section 67 of the Finance Act, 1994, shall always keep the above ratio in mind, before prescribing the value for their respective levies.

The ratio explained by the Apex Court in the BSNL case[6] as stated above explains the aspect theory and its justification as follows:

1. Consequent to the 46th Amendment to the Constitution whereby an amendment was effected to Art. 366 (29A), the State is empowered to tax composite contracts like Works contracts, hire purchase contacts and catering contracts.

2. Apart from the works contracts and catering contracts where splitting of the service and supply has been constitutionally permitted in Clauses (b) and (f) of Clause 29A of Art. 366, there is no other service which has been permitted to be so split.

3. The test therefore for composite contracts other than those mentioned in Article 366 (29A) continues to be – did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention then there is no sale even if the contract could be disintegrated. The test for deciding whether a contract falls into one category or the other is to as what is the substance of the contract.

4. Goods may be a tangible property or an intangible one. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) capable of being bought and sold; and (c) capable of being transmitted, transferred, delivered, stored and possessed. If a software whether customized or non-customised satisfies these attributes, the same would be goods.

5. Delivery of goods may not be simultaneous with the transfer of the right to use. But the goods must be in existence and deliverable when the right is sought to be transferred and therefore whether the goods are incorporeal or corporeal, tangible or intangible, they must be deliverable.

6. The same transaction may involve two or more taxable events in its different aspects.

7. The State shall not entrench upon the Union List and tax services by including the cost of such service in the value of the goods. Similarly, the Centre cannot include the value of the goods, in the cost of the service.

Thus, the principal question to be decided in these matters is the nature of the transaction. It needs to be determined that whether it is a sale or is it a service or both. If it is a sale then the States are legislatively competent to levy sales tax on the transaction under Entry 54 of List II.

If it is a service, then the Central Government alone can levy such service tax under Entry 97 of List I or Entry 92C of List I. And if the nature of the transaction shares in with both the characters of sale and service, then the moot question would be whether both legislative authorities could levy their separate taxes together or only one of them.[7]

The answer to this principal question has been fairly explained with the above citations and it stands corrected that although aspect theory justifies the overlapping of central and state taxes and on the same commodity, goods or services but the aspect on which the tax shall be levied on such good, service or commodity must be different and then only the overlap will not be unconstitutional.

To solve this problem, the Goods and Service Tax (GST) regime can be brought forward in the taxation system whereby broad based ‘consumption tax’ may be applied on the goods and services. Implementation of subsuming the State and Central indirect taxes in this Goods and Service Tax regime. Input credit can be made available to goods and services across each stage. This GST may subsume various indirect taxes like VAT, Excise and Service Tax. This proposition of GST is mainly to bring homogeneity in the definitions and uniformity towards the tax rule across India and this may help in ending the anomaly that exists till date.

[1] All India Federation of Tax Practitioners v. Union of India 2007 – TMI – 1556 SUPREME COURT

[2] Shilpa Color Lab v. CCE, Calicut 2006 – TMI – 1022 – (CESTAT, BANGALORE)

[3] Federation of Hotel & Restaurant Assn. of India v. Union of India 1989 – TMI – 40104 SUPREME COURT

[4] 2006 TIOL – 15 – SC – CT – LB

[5] 2005 – TIOL – 53 – SC – ST

[6] Bharat Sanchar Nigam Ltd. v. Union of India 2006 TIOL – 15 – SC – CT – LB

[7] BHARAT SANCHAR NIGAM LTD Vs UNION OF INDIA

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