Guest Post: Fiscal Federalism and the Centralising Drift – The Supreme Court’s GST Judgment

[This is a guest post by Suhrith Parthasarathy.]

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In July 2017, the Government of India heralded a goods and services tax regime by bringing forth the 101st amendment to the Constitution through an unusual midnight session of Parliament. The government claimed the new tax would unify the Indian market. Any fears that the tax would disrupt Indian federalism were sought to be eased by describing the effort as an example in cooperation between the states and the Union. The then chief economic adviser to the government of India, Arvind Subramanian, described the move as a “voluntary pooling of sovereignty”.

The phrase “pooled sovereignty” owes its origins to the creation of the European Union, where member states agreed to delegate some of their decision-making powers to the council. In the case of the GST, the idea was that both Parliament and the state legislatures would delegate some of their power to a newly formed GST Council that would help make a unified law for the nation. All along, it was believed that the Council’s decision would be binding on each of the states and that any dispute that a state wanted to raise would have to be resolved within the structures built into the system. 

This idea, seen as foundational to the functioning of the GST, has come under threat from a judgment of the Supreme Court, in Union of India v. Mohit Minerals, where a 3-judge bench, presided by Justice DY Chandrachud, has held that the GST Council’s decisions are not binding on legislative bodies and that both Parliament and the state legislatures possess plenary powers to make laws as they deem fit. How states react to this finding and to what extent they choose to amend their respective GST legislations might come to have a deep bearing on the future of Indian federalism.

In framing the Constitution, the Constituent Assembly was conscious of making careful divisions of power between the Union and the state governments. Although there were certain areas in which the Union was accorded pre-eminence, when it came to taxation, the framers were keen to vest in the States substantial responsibility. The compartments that were drawn out ensured that the powers of taxation were not mutually exclusive. Income tax (excepting tax on agricultural income) was offered to the Union, along with some indirect taxes such as customs and excise duties. State governments, on the other hand, were given the exclusive authority to tax both sale of goods and the entry of goods into a state. This division was made by inserting these subjects respectively into Lists I and II of Schedule VII of the Constitution. Critically, the concurrent list, that is List III, did not contain any taxing subject. Therefore, on a reading of Articles 245 and 246 and the entries in Lists I and II of Schedule VII, a clear division of power between the Union and the states could be gleaned out.

The 101^st amendment toppled this arrangement. It removed from List II a slew of subjects over which hitherto the state government had enjoyed absolute power. These included, for example, entry 52, which was “taxes on the entry of goods into a local area for consumption, use or sale therein”; and entry 55, which dealt with taxes on advertisements. Entry 54 was substituted by a new entry, which had the effect of removing the power to tax on sale or purchase of goods excepting certain categories of products, such as fuel, natural gas, and liquor. The amendment also introduced a new provision, Article 246A, which would, as a stand-alone clause, provide a power to tax goods and services. Article 246A reads as follows:

“(1) Notwithstanding anything contained in articles 246 and 254, Parliament, and, subject to clause (2), the Legislature of every State, have power to make laws with respect to goods and services tax imposed by the Union or by such State.

(2) Parliament has exclusive power to make laws with respect to goods and services tax where the supply of goods, or of services, or both takes place in the course of inter-State trade or commerce.

Explanation.—The provisions of this article, shall, in respect of goods and services tax referred to in clause (5) of article 279A, take effect from the date recommended by the Goods and Services Tax Council.]”

As we can see, Article 246A begins with a non-obstante clause. It overrides the general power to legislate vested in Parliament and the state legislatures through Article 246. It also overrides Article 254, which deals with inconsistencies—including repugnancy—between laws made by Parliament and a state legislature. To give effect to the proposed exercise of unification the 101st amendment introduced a Goods and Services Tax Council through Article 279A. The GST Council comprises the Union Finance Minister (who shall act as a chairperson), the Union Minister of State in charge of Revenue or Finance and the Minister in charge of Finance or Taxation or any other Minister nominated by each State Government.

Article 279A(4) stipulates that the GST Council “shall make recommendations to the Union and the States on (a) The taxes, cesses and surcharges levied by the Union, the states and the local bodies which may be subsumed in the Goods and Services tax; (b) The goods and services that may be subjected to, or exempted from the GST; (c) Model GST Laws, principles of levy, apportionment of Goods and Services tax levied on supplies in the course of inter-state trade or commerce under Article 269A and the principles that govern the place of supply; (d) The threshold limit of turnover below which goods and services may be exempted from GST; (e) The rates including floor rates for specified period, to raise additional resources during any natural calamities or disaster; (f) Special provision with respect to the states of Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Uttarakhand and Himachal Pradesh (Referred as Special Category States (g) Any other matter relating to the goods and services tax, as the council may decide.” [Emphasis is mine].

Article 279A(9) states that “Every decision of the Goods and Services Tax Council shall be taken at a meeting, by a majority of not less than three-fourths of the weighted votes of the members present and voting, in accordance with the following principles, namely:— (a) the vote of the Central Government shall have a weightage of one-third of the total votes cast, and (b) the votes of all the State Governments taken together shall have a weightage of two-thirds of the total votes cast, in that meeting.” [Emphasis supplied].

Article 279A(10) and (11) read as follows:

“(10) No act or proceedings of the Goods and Services Tax Council shall be invalid merely by reason of— (a) any vacancy in, or any defect in, the constitution of the Council; or (b) any defect in the appointment of a person as a Member of the Council; or (c) any procedural irregularity of the Council not affecting the merits of the case. (11) The Goods and Services Tax Council shall establish a mechanism to adjudicate any dispute— (a) between the Government of India and one or more States; or (b) between the Government of India and any State or States on one side and one or more other States on the other side; or (c) between two or more States, arising out of the recommendations of the Council or implementation thereof.]”

The language used in Article 279A is somewhat puzzling. The provision uses the word “recommendation” to refer to the GST Council’s advice (which includes advice on a model law) but it also terms the results of the Council’s deliberations as decisions. What is more, it establishes a mechanism to adjudicate disputes that might arise between governments on any decision taken by the council. If one thinks of the GST as a unitary tax, and if the GST has to work in the manner in which it was conceived by the Union government, any advice proffered by the GST Council would necessarily have to be binding on the states—there is no question of allowing a variation in laws, as that would defeat the idea of having a single tax and a single market. This would, of course, mean that the 101^st amendment will have to be seen as dismantling the nature of fiscal federalism that the Constitution in its original form established.

But perhaps because there was no other way the government’s idea could be workable, almost right from its inception, the GST Council’s decisions were viewed as binding on the states. Even when states seriously contested a piece of advice that had been offered, they nonetheless acted on such advice. And for this reason, many states also believed that the Council and its workings impinged on powers vested in the states by the Constitution. In other words, it was thought that the 101^st amendment violated the federal arrangement in a manner that had the effect of effacing one of the basic features of the Constitution.       

The judgment now delivered in Mohit Minerals does not concern itself directly with any of these questions. The case arose out of an appeal filed by the Union government against a judgment of the Gujarat High Court. The High Court had declared a levy of Integrated Goods and Services Tax [IGST] imposed on importers, on ocean freight charges paid by foreign sellers to foreign shipping lines. The court had found that the importers were already paying a tax on the composite supply that was made and that to impose an additional levy on just the ocean freight would be tantamount to a form of double taxation. Moreover, in the case of CIF contracts (Cost, Insurance and Freight contracts), both the service provider and the service recipient were outside the territory of India, and the tax itself was being cast on an importer, who, in the first place, was not the recipient of the service.

During arguments in the Supreme Court, the Union government argued that this decision to levy tax on ocean freight had been made by the GST Council and that the government was, as such, bound by it. In examining this question, the Supreme Court considered the purport of Article 279A and made a series of findings, which could potentially dismantle the idea of GST, as understood through the 101^st amendment. The court did not explicitly premise these findings on the Constitution’s basic structure—its analysis was largely predicated on the text of the Constitution and on what it regarded as Parliament’s intention behind the 101^st amendment. But the underlying philosophy of the basic structure doctrine was nonetheless at play. The court found that to hold the GST Council’s recommendations as binding would have the effect of impinging on legislative powers granted by the Constitution, and would, in the process, alter “fiscal federalism”.

The court recognised that there were two chief arguments in favour of seeing the GST Council’s recommendations as binding. First, if one sees the recommendations as just that, the “GST will collapse as each State would then levy a conflict tax and collection mechanism”; second, if the recommendations are non-binding there would be no dispute to resolve under Article 279(11) as the States would be free to disregard the recommendations. In the same vein, the court also recognised the two chief arguments against seeing the GST Council’s recommendations as binding. First, it would violate the supremacy of Parliament and the state legislatures since both have been afforded “simultaneous” legislative power on GST; second, the virtual veto given to the Union in the GST Council would lead to a violation of fiscal federalism.

Having recognised these arguments, the court proceeded to analyse and lay down the broad contours of India’s federal structure. It cited, among others, HM Seervai who in arguing that India was a federal state, pointed to important powers that had been vested exclusively in the state governments. “The view that unimportant matters were assigned to the States cannot be sustained in face of the very important subjects assigned to the States in List II, and the same applies to taxing powers of the States which are made mutually exclusive of the taxing powers of the Union so that ordinarily the States have independent source of revenue of their own,” wrote Seervai. “The legislative entries relating to taxes in List II show that the sources of revenue available to the States are substantial and would increasingly become more substantial. In addition to the exclusive taxing powers of the States, the States become entitled either to appropriate taxes collected by the Union or to a share in the taxes collected by the Union.”

The Court then proceeded to examine the language used in Article 246A. It saw that the provision granted to both Parliament and the state legislature co-equal power. That is, the legislative bodies were given simultaneous authority to legislate on GST within their respective jurisdictions. This was, the court said, a sui generis provision, containing “unique features” of federalism. “Article 246A treats the Centre and States as equal units by conferring a simultaneous power of enacting law on GST. Article 279A in constituting the GST Council envisions that neither the Centre nor the States can act independent of the other.” The court said that it was aware that there are certain areas in the Constitution where the division of power is lopsided, where the arrangement provides for a centralising drift. But that such provisions exist cannot take away from the fact that there might be other areas where the central and state governments are given equal power. The court also noted that the Constitution, after the 101^st amendment, does not provide for a mechanism to resolve any repugnancy or inconsistency between a parliamentary and state law. This would mean that the GST Council would have to strive to work in a harmonised manner, but at the same time this cannot mean that the GST Council’s decisions will override the basic legislative power vested in the state governments.

Contrary to the much vaunted idea of cooperative federalism that was seen as underlying the GST, the court held—cited scholarship by Jessica Bulman-Pozen and Heather K. Gerken—that what the regime in fact promotes is a form of “uncooperative federalism.” This contestation, Justice Chandrachud wrote, is “valuable since ‘it is desirable to have some level of friction, some amount of state contestation, some deliberation-generating froth in our democratic system.’ Therefore, the States can use various forms of contestation if they disagree with the decision of the Centre. Such forms of contestation are also within the framework of Indian federalism. The GST Council is not merely a constitutional body restricted to the indirect tax system in India but is also an important focal point to foster federalism and democracy.” If the GST Council works not merely through cooperation but also through contestation, and arrives at decisions in a democratic manner, there will be, the court believed, no need for any fears that the taxing regime will crumble as a whole.

To augment this holding the court referred to the bare language used in Article 279A. The word “recommendation”, the judgment found, is used in an array of different constitutional provisions. And the meaning ascribed to it is invariably contextual. In this case, it was impossible to see the word “recommendation” as meaning “binding recommendation” because if that was Parliament’s intention behind the 101^st amendment, a qualification to that express account would have been included in Articles 246A or 279A. “Neither does Article 279A begin with a non-obstante clause nor does Article 246A provide that the legislative power is ‘subject to’ Article 279A,” the court held. But the Union also claimed that the legislatures, both Parliament and the states’, had effectively ceded their power. An analysis of many of the provisions of the Central Goods and Services Tax Act, and, for that matter, the state GST legislations, expressly stipulate that the rule-making power delegated to the Government will be exercised on the recommendations of the GST Council. As examples, the Supreme Court cited Section 5 of the IGST Act, which provides that the taxable event, taxable rate, and taxable value shall be notified by the government on the “recommendations of the Council”. Similarly, the power of the Central Government to exempt goods or services or both from levy of tax shall be exercised on the recommendations of the GST Council under Section 6 of the IGST Act. Section 22 provides that the Government may exercise its rule making power on the recommendations of the GST Council. The CGST Act also provides for similar provisions in Sections 9, 11 and 164. Apart from these, a look at the state GST legislations also showed that similar mandates were made by state legislatures. For instance, Section 9(1) of the Tamil Nadu GST Act reads as follows:  “Subject to the provisions of sub-section (2), there shall be levied a tax called the Tamil Nadu goods and services tax on all intra-State supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, on the value determined under section 15 and at such rates, not exceeding twenty per cent., as may be notified by the Government on the recommendations of the Council and collected in such manner as may be prescribed and shall be paid by the taxable person.”

A reading of this clause would indicate that the state government is bound by the advice of the Council. For that matter, this clause and each of the provisions of the State GST Act was incorporated on the basis of the model law prescribed by the Council. But what if the legislature amends Section 9(1) and allows the government to deviate from the recommendation made by the council? According to the Supreme Court, the scheme of the 101^st amendment does indeed allow for such amendments to be made, because the GST Council’s recommendations can never constrain the basic legislative power prescribed in Article 246A. A reading of Paragraph 59 of the Supreme Court’s judgment is instructive:

“59. The provisions of the IGST Act and CGST Act which provide that the Union Government is to act on the recommendations of the GST Council must be interpreted with reference to the purpose of the enactment, which is to create a uniform taxation system. The GST was introduced since different States could earlier provide different tax slabs and different exemptions. The recommendations of the GST Council are made binding on the Government when it exercises its power to notify secondary legislation to give effect to the uniform taxation system. The Council under Article 279A has wide recommendatory powers on matters related to GST where it has the power to make recommendations on subject matters that fall outside the purview of the rule-making power under the provisions of the IGST and CGST Act. Merely because a few of the recommendations of the GST Council are binding on the Government under the provisions of the CGST Act and IGST Act, it cannot be argued that all of the GST Council’s recommendations are binding. As a matter of first principle, the provisions of the Constitution, which is the grundnorm of the nation, cannot be interpreted based on the provisions of a primary legislation. It is only the provisions of a primary legislation that can be interpreted with reference to the Constitution. The legislature amends the Constitution by exercising its constituent power and legislates by exercising its legislative power. The constituent power of the legislature is of a higher constitutional order as compared to its legislative power. Even if it is Parliament that has enacted laws making the recommendations of the GST Council binding on the Central Government for the purpose of notifying secondary legislations, it would not mean that all the recommendations of the Council made by virtue of its power under Article 279A have a binding force on the legislature.”

It is my submission that this finding by the Supreme Court in paragraph 59, which has a potentially far-reaching effect, is correct and laudable. Critics of the judgment may well point to the fact that in allowing the state legislatures plenary power to legislate beyond the Council’s recommendations the court has potentially allowed a pathway for a collapse of the GST regime. But the court’s interpretation is predicated on two things: one, the bare text of the Constitution, in that Article 279A uses the word “recommendation” and in that Article 246A does not limit in any manner the equal power granted both to the Parliament and the state legislatures; two, that any other interpretation would allow the federal compact, as originally conceived by the framers, to collapse. In other words, what is at stake here is the Constitution’s basic structure. Upholding that structure requires us to see both the Union and the state governments as equal partners.

The judgment in Mohit Minerals is not a comment on fiscal policy or on the merits of a unified taxing regime. If such a regime is desirable, then it is up to the Union and the state governments to arrive at a consensus through democratic deliberation, whether within the confines of the GST Council or outside of it. But if a state government believes that it must disregard some decision or the other of the Council, its basic legislative power to do so cannot be arrogated. To ascribe any other meaning to the 101^st amendment would only render it a nullity.