By Mukesh Butani & Shankey Agrawal
Last week, the Supreme Court affirmed the Gujarat High Court’s decision to set aside the GST Levy on Ocean Freight Service on CIF contracts under the reverse charge mechanism. In conclusion, the court, upholding the constitutional validity of notifications issued by the Union of India, negated taxpayers’ arguments that the notifications were extra-territorial. To the extent a CIF contract entails an Indian importer to pay for the ocean freight, it creates a deeming fiction as the importer essentially becomes a “recipient” of freight services. SC concluded that given the destination-based principle under the GST framework, no doubt, importing goods into India would be a taxable supply as the place of supply of ocean freight would be India. However, the case turned against the government under a common-sense analogy of double taxation and contradictions. The apex court held that import transactions, already subject to the GST levy (under import supplies) read with the Customs law, could not be subjected to a fresh levy on the ocean freight service component. SC refused to accept the Union’s arguments that the import of goods was independent of freight service and, in conclusion, remarked that such a GST levy is not valid as the GST framework does not empower the government (pointing to the notifications) to shift the GST levy on the importer despite the GST Council’s recommendation. The judgment assumes greater significance given the observations and far-reaching insights into the role of the GST Council considering the 101st Constitution amendment of 2016, which paved the way for GST rollout.
The GST rollout faced many hurdles due to the then constitutional scheme which divided the states’ and the Centre’s powers for levy of tax on goods and services. However, it became a reality when both the Centre and the state governments legislated in unison as part of the grand bargain. In other words, they pooled their sovereign taxation powers and did not cede them. This fine distinction best describes the dual-power levy of GST, which very few jurisdictions have with Canada being a prime example. In amending the Constitution to encompass such dual levy, the GST Council was formed with the Union finance minister and the finance ministers of each state as members. The Council ensures uniformity in the implementation by eliminating any inconsistencies and is instrumental in promoting the ‘One National Market’ principle. However, the Constitution mandates that all decisions of the Council must be taken by a three-fourths majority and practically provides veto powers to the Centre as it holds one-third of the voting power.
While interpreting the constitutional role and functions in the context of simultaneous legislative powers of the Centre and the state, the SC concluded that the decisions of the GST Council are only recommendatory and not binding. This part of the judgment has created anxiety and raised apprehensions if it disrupts the design of GST. Some experts have argued that the apex court has pointed out defects in the Constitution amendment design. It could be interpreted to mean that the Union and states can choose to legislate whether to follow the recommendations of the GST Council, particularly now that the SC has held that it is not binding?
In our view, such concerns are unfounded. Firstly, (recommendatory) decisions of the GST Council cannot be automatically implemented. The constitutional design mandates only Parliament and the state legislatures to pass respective legislation for the implementation. SC has highlighted this aspect by pointing out that power (for levy of tax) cannot be abdicated to the Council. It is, however, possible that a state legislation may decide not to implement the Council’s recommendation. Parliament and the legislature of each state government enjoy unfettered rights to pass legislation, which any constitutional body cannot hamper. The SC has merely affirmed such sovereign rights of the Centre and the states. It is important to note that the verdict in favour of the taxpayer is solely based on the principle of violation of the “composite supply” theory enshrined in the law, as the notifications were attempting to levy dual taxation on import supplies and freight services. Perhaps the SC was drawn into the debate due to the government’s contention that the GST Council recommendations are akin to a binding mandate of law. This aspect, in our view, has led the SC to unravel the design aspects of the GST law and its precedent Constitution amendment to conclude the recommendatory role of the Council.
The SC judgment does concern GST Council’s empowerment and sanctity of its decisions. However, if the past is any indication, there is little to worry about as the Centre and the states have worked with a conscious spirit of cooperative federalism. All decisions of the Council were taken by consensus, except the decision in the case of taxation of lotteries, wherein seven states voted against the proposal. This outlier situation was differing views inter se between states and didn’t entail Centre-state friction. There has been consensus on all critical issues, including rates and classification aspects. Though the Constitution provides for a dispute resolution mechanism in case of disputes arising from the Council’s recommendations or its implementation thereof, a framework to deal with it has not been prescribed. Perhaps, the verdict is an apt moment to specify such a mechanism to preserve the uniformity and consistency of implementation.
It would be premature to assume that the uniform structure of GST would be distorted due to the non-binding nature of the GST Council’s recommendations. GST was conceived as a grand bargain between the Centre and states—for states to protect their tax base and cede power of taxation and the Centre to share its ability to maintain oversight on its governance —by way of the GST Council. The success of GST requires the said bargain to continue in the right spirit of cooperative federalism keeping political agendas aside. It would otherwise harm domestic and international businesses and give another reason to raise the bogey of tax uncertainty.
Mukesh Butani & Shankey Agrawal, Partners, BMR Legal. Views are personal.