[This is a guest post by Karan Trehan].

This article continues the previous post analyzing Supreme Court’s [‘SC’] verdict in Union of India v. Mohit Minerals. To give a brief overview, Section 18 of the Constitution (One Hundred and First Amendment) Act, 2016 [‘GST Amendment Act’] enables Parliament to enact a ‘law’ compensating States for loss in revenue due to the implementation of Goods and Services Tax [‘GST’]. In order to effectuate this goal, GST (Compensation to States) Act, 2017 [‘CSA’] was passed by the Parliament, levying a cess on intra-State and inter-State supply of goods or services. (Section 8 of the Act levies the cess)

The SC in Mohit Minerals upheld the legislative competence of the CSA Act sourcing its validity through Article 270. The court pointed out that Article 270, post the GST Amendment Act specifically empowers Parliament to levy any cess by law. Although the SC emphasized that Section 18 of the Amendment Act also grants power to Parliament for compensating States, this factor did not form the basis of court’s decision.

In previous post, it was contended firstly, that Section 18 forms a part of the Constitution despite not being reflected in its bare text; and secondly, that the SC could have sourced the validity of GST (Compensation to States) Act, 2017 through Section 18 of 101st Amendment Act without going into Article 270 insofar as the ‘law’ framed is for compensating the States.

It has been argued here that Article 270 does not grant any power to levy ‘cess’ and merely provides a distribution mechanism for taxes levied and collected by the Union. Thus, the reliance by the SC on Article 270 for validating CSA Act is erroneous. Furthermore, the proposition whether a ‘law’ framed under Section 18 can contemplate levy of cess has also been explored.

Article 270 does not grant any power to levy ‘cess’

Article 270 is titled ‘Taxes levied and collected by the Union and distributed between the Union and the States’. Clause 1 of the Article provides that:

(1) All taxes and duties referred to in the Union list, except the duties and taxes referred to in articles 268, 269 and article 269A, respectively (Read as “Articles 268, 268A and 269″ prior to the GST Amendment Act), surcharge on taxes and duties referred to in article 271 and any ‘cess’ levied for specific purposes under any law made by Parliament shall be levied and collected by the Government of India and shall be distributed between the Union and the States in the manner provided in clause (2).

On a plain reading, the article describes a framework for distribution of net proceeds between the Union and the States through a law framed in accordance with the procedure laid down in clause (2). It is in clause (2) of Article 270 that we find a reference to percentage of distribution. The manner of such percentage has to be prescribed by the Finance Commission; until a Finance Commission has been constituted, it can be prescribed by the President by Order and after the Finance Commission has been constituted, it shall be prescribed by the President by Order after considering the recommendations of the Finance Commission.

The GST Amendment Act has added Clause 1A and 1B after clause (1) of Article 270 which now reads as:

(1A) The tax collected by the Union under clause (1) of article 246A shall also be distributed between the Union and the States in the manner provided in clause (2).

(1B) The tax levied and collected by the Union under clause (2) of article 246A and article 269A, which has been used for payment of the tax levied by the Union under clause (1) of article 246A, and the amount apportioned to the Union under clause (1) of article 269A, shall also be distributed between the Union and the States in the manner provided in clause (2).’’

Thus, after the GST Amendment, the manner in which taxes collected under Article 246A are distributed has also to confirm the procedure prescribed under Article 270.

(Separate Note: It is the GST Council constituted as per Article 279A which recommends the percentage of taxes to be distributed between Union and States under 246A. Now clause IA and IB says that GST taxes has to be distributed as per clause (2) that in turn makes reference to the procedure ‘prescribed’ under clause (3). Considering this, Clause (4) which defines the term ‘prescribed’ should have been amendment to include recommendation by the GST Council which has (interestingly) not been done with the ambit being still limited to recommendations by Finance Commission.)

Coming back to the core issue, it has to be considered that the Indian Constitution does not define ‘cess’ and it is only in Article 270 that a reference to this terminology can be traced. Article 270 uses the expression “any ‘cess’ levied for specific purposes under ‘any law’ made by Parliament”.

The relevant question which now arises is:

Whether ‘any law’ referred to under this Article means a law enacted under Article 270 itself or a law enacted in the exercise of plenary taxing powers granted to the Parliament under Article 245 and 246 r/w List I of Schedule VII?

Cess Tax in India

Before delving any further, it become important to understand the concept behind cess. The term ‘cess means a tax and is ordinarily employed when the levy is for some special administrative expense or purpose (Similar to what has been stated under Article 270). Though the term ‘cess’ has been used traditionally to mean a tax, it may also take the form of a ‘fee’, and the term ‘cess tax’ only refers to a cess with the nature of a tax.

Generally, taxes raise revenue which can be utilized for any purpose. For example, the revenue received from Income Tax can be put to any use by the Union Government viz. infrastructure building, payment of outstanding debts etc. However, cess tax differs from a tax in the sense that the former is earmarked for a specific purpose whereas the latter does not necessitate any earmarking. Examples can be education cess which is solely utilized for educational purposes or Krishi Kalyan Cess only meant for welfare of farmers.

Despite the peculiarities, the nature of cess tax and tax is essentially identical and a cess tax can, at best be described as a special form of tax with only difference being in terms of purpose and distribution. Since both the terms mean one and the same thing, it further follows that authority to levy cess tax would also flow from the legislative power to impose a tax.

Article 265 of the Constitution lays down that: ‘No tax shall be levied or collected except by authority of law.’ Thus, not only ‘levy’ but also ‘collection’ of taxes must be under authority of some law and any act by the State purporting to impose a tax without any legislative authority will be void. This power to impose taxes can be traced to Article 245, 246 and 248 read with specific Entries in the Lists under Seventh Schedule. In addition, Article 246A also empowers the legislature to levy GST independently of Schedule VII.

Thus, Article 270 only deals with the ‘collection’ part and the law-making power assigned under this article is limited to the extent it empowers Parliament to enact a legislation laying down the manner of distributing revenue collected from taxes. This implies that the usage of expression ‘Taxes levied and collected by the Union’ under various sub-clauses is ‘merely’ a reference to respective taxing entries under the Constitution.

Legislative History

This argument can further be corroborated by analyzing the legislative history of this provision. Article 270 is, in major part, derived from the Government of India Act, 1935 [‘GOI Act’] and it is this legislation one needs to turn in order to discern the true nature of the article. Section 137 – 141 of Part VII in the GOI Act dealt with the financial framework for levy and collection of different taxes viz. succession duties, terminal taxes, Income tax other than agriculture, corporation tax etc. by Federation and its distribution between Federation and provinces. The power to levy and collect agriculture and certain other taxes were however vested with the provinces.

These provisions (similar to Article 270) also incorporate the expression “Taxes …… ‘shall’ be ‘levied’ and collected by the Federation”. The above expression, when read in isolation gives the impression that these sections grant taxation powers to the Federation. However, it was Section 100 of GOI Act (similar to Articles 245 and 246) which in actuality conferred taxing (also law making) powers and demarcated fields of legislation between Federation and Provinces into three lists, with local subjects in List II and III and pan-India subjects in List I.

Article 270, as we see now, is a consolidation of these provisions (primarily, Section 138 which dealt with Income other than agriculture income) with modifications introduced through amendments post enactment of the Constitution.

It is also important to note that the GOI Act had no reference to the term cess. In fact, cess does not even appear in the original Article 270 and it was only through the Constitution (Eightieth) Amendment Act, 1999 the term ‘cess’ was introduced with the sole aim of “providing an alternative scheme of sharing the proceeds from certain Union taxes and duties between the Union and the States leaving sufficient flexibility for meeting Centre’s exclusive needs by keeping Cesses and Surcharges outside the pooling arrangement”. Hence it can be inferred that the intention behind including cess under Article 270 was to protect proceeds from certain taxes (or fees) levied for specific purpose in hands of the Union and prevent their mandatory distribution amongst various States. This means that power to levy taxes is still available under relevant legislative entries and ‘any law’ under clause (1) appearing in the context of cess refers only to taxing entries under Schedule VII. Hence, there is no way reliance could have been placed on clause 1 of Article 270 for validating cess under GST owing to its limited application only to direct taxes (and law-making power under Schedule VII).

Cess can be levied through a law framed under Section 18

Section 18 of GST Amendment act reads:

Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax for a period of five years.”

It has been earlier established (here) that Section 18, though not reflected in the text of Constitution, can be relied to frame a law for compensating the States. What remains to be analyzed now is “whether such law framed under this provision can be used to levy cess?”

Since power to levy a cess (whether ‘tax’ or ‘fee’) comes from specific entry and for a cess tax, reliance has to be placed on specific tax entry. Article 246A is the stand-alone charging provision in context of Goods and Services Tax and operates independently of lists under Schedule VII. This means that any cess tax levied under GST regime will have to be necessarily sourced from Article 246A. Thus, the law-making powers granted under Section 18 can levy cess and have to be read along with Article 246A for such imposition.

Section 18 as an exception to Article 270 1(A) and 1(B)

As discussed earlier, Article 270 (1) provides for the manner in which direct taxes and other levies under Union list have to be distributed between Union and States with some exceptions being explicitly carved out for certain duties including cess imposed for specific purpose in the provision itself. This means that these levies specifically exempted do not have to follow similar disbursement method as others (not falling under exception) collected under 270(1).

Article 270 1(A) and 1(B) lay down the standard distribution mechanism for indirect taxes (GST) collected under Article 246A. On comparing clause (1) with clause (1A) and (1B) it can be observed that the distribution role which former plays with respect to direct taxes (and other levies under Union list), is being carried out by Article 270 1(A) and 1(B) for GST. It has to be noted that the latter however does not lay down any exception to this compulsory distribution rule.

Now Section 18 which enables imposition of Compensation to States cess also forms a part of entire GST regime. Under Compensation to States Act, 2017 an elaborate procedure has been laid down how cess collected under Section 18 has to be distributed. Thus, ‘cess’ levied under this provision does not have to follow the mandatory mechanism prescribed under Article 270 (1A) and (1B) due to the separate distribution procedure being laid down under Compensation to States Act, 2017 itself.

To put it simply, though any tax collected under GST regime has to be distributed according to the manner provided under Article 270 (1A) and (1B), only when it comes to cess levied for compensating the States, mechanism as per CSA Act, 2017 framed under Section 18 has to be followed.

Hence, Section 18 can be seen exception to the compulsory distribution rule for GST prescribed under Clause (1A) and (1B). It operates in the same capacity as cess (and other) exception in Article 270(1) for direct taxes levied under Union List with special purpose of cess limited to compensate the States. (Clause (1) of 270 has no mention of any specific purpose and leaves such determination entirely upon discretion of appropriate legislature.)