Late last week, amid the excitement over demonetisation and American elections, many may have missed a significant judgment delivered by a bench of nine judges of the Supreme Court, on the constitutional validity of various state “entry tax” statutes (“entry tax” being a state levy on the entry of goods into a local area). There are only eight prior reported judgments by a bench of nine judges. The size of the bench itself, therefore, signals the importance of this case.
The Court ultimately tilted in favour of the states (by a majority of 7:2, with Justice Ashok Bhushan and Justice DY Chandrachud dissenting). Some may only look to the short-term implications of this case, namely the flow of arrears from the assessees to the states. Others may even say that this decision will have no long-term implications at all, due to the Constitution Amendment Act, 2016 (forming part of the GST reform package), which deletes Entry 52 of the List II, Schedule 7 of the the Constitution of India (to which states trace the power to levy entry tax). However, the significance of this judgment lies in the fact that it will, without doubt, impact India’s essential character as an economic union in the long-term, since the idea of freedom of trade within India lies at the core of this decision.
Article 301 of our Constitution essentially guarantees free trade, commerce and intercourse throughout the territory of India (subject to the remaining provisions contained in Part XIII of the Constitution, namely Article 302-307). In 1961, in the famous Atiabari Tea Company judgment, a majority of five judges of the Supreme Court held that a tax that has the direct and immediate effect of impeding free flow of trade and would fall foul of Article 301. In that case, the Court was looking into the levy of tax on manufactured tea carried in chests by road or waterways by Assam. The next step, therefore, was to see whether this tax was justified under Article 304, which was seen to carve out two exceptions to the free trade rule in Article 301 namely–that a state could impose any tax on goods imported from outside the state to which goods manufactures/produced in that state are subject (Art 304(a)); and, that a State could impose such “reasonable restrictions” on freedom of trade with or within that State, as may be required in public interest, provided that the President sanctioned such a measure (Art. 304(b)).
Two years later, in the Automobile Transport case, a bench of seven judges read into Part XIII, and its free trade provisions, the idea that “regulatory” and “compensatory” measures, used to facilitate trade, could not be seen to impact freedom of trade. For instance, a tax levied for the use of a bridge utilised for the upkeep and maintenance of that bridge would be a compensatory tax, outside the purview of Article 301.
Since the 1960s, the law of freedom of trade has ebbed, flowed and eddied in various directions, and these movements are essentially what led to a reference being made to nine judges, in the entry tax cases, to put to rest the internal conflicts and contradictions that were created in the last fifty odd years of jurisprudence surrounding Part XIII. Instead, the court may actually have compounded the confusion. Apart from discarding the “compensatory tax” theory, the court has done away with the one core idea that has remained constant since the Atiabari case in 1961, namely that some taxes can, in certain circumstances, impact the free flow of trade. Indeed, the idea that taxes can create a hindrance in trade is internationally accepted (for which one does not need to look beyond the General Agreement on Tariffs and Trade, which is central to the regulation of international trade). For some reason, however, the SC did not seem to accept the commercial reality of tariff barriers, holding, somewhat disingenuously, that “taxes whether high or low do not constitute restrictions on the freedom of trade and commerce.”
According the the Court, the only way a tax can be challenged is under Article 304(a) alone, on the ground that it discriminates against goods manufactured outside the State. However, the bar has been set very high, in holding that only “unfavourable bias” amounts to discrimination, whereas differentiation actuated by internal economic justifications (such as promotion of industrial activity within the state) is perfectly acceptable. Again, the Court seems to have ignored commercial reality, namely that discriminatory tariff walls and protectionism are almost always sought to be justified by internal economic reasons on the part of the government imposing the tax. In holding that differentiation may be justified by “a legitimate desire to promote industries within its territory”, the SC has essentially given states a much greater leeway to erect tariff walls, at the cost of free trade, diluting the vision of the framers of our Constitution of creating an economic and fiscal union, championed by the likes of TT Krishnamachari and Alladi Krishnaswami Ayyar in the Constituent Assembly. It remains to be seen whether, in strengthening the hands of the states, the Court has actually weakened the core philosophy behind measures like the GST, namely that India should be a seamless, common market with a unified tax structure.
In respect of short term effects, the arrears (estimated to be about R30,000 crore) may not have to be immediately paid, because the regular bench of the SC, as also High Courts before which cases are pending, would have to test each specific legislation under Article 304(a) on the parameters given by this nine judge bench and pass a ruling, since the bench has refrained from dealing with particular cases and specific state legislations. Two thousand cases are pending before the SC, with hundreds more before the HC, therefore the process of realising arrears may be staggered. Two questions of law have also been left open, namely whether the entire state can be designated as a “local area” for entry tax purposes, and whether entry tax can be levied on goods entering the landmass of India from another country, so any cases involving one of these questions would require another round of adjudication. However, whatever may be the fate of the arrears, one can only hope that the SC, in years to come, gets an opportunity to revisit this nine-judge bench decision, and restore the balance in favour of free trade.
The author is an advocate practicing in the Supreme Court of India. Views are personal