State levy of Entry tax in India upheld by the Supreme Court

A constitution bench comprising of nine judges, on November 11, 2016 upheld the constitutional validity of entry tax levied by various states on goods entering their territory in a 7:2 majority ruling. The legality of entry tax was scrutinized by the division bench of Chief Justice T. S. Thakur, Justice A.K. Sikri, Justice S. A. Bobde, Justice Shiva Kirti Singh, Justice N.V. Ramana, Justice R. Banumathi, Justice A.M. Khanwilkar, Justice D.Y. Chandrachud and Justice Ashok Bhushan over arguments between companies and states.

Entry tax is a tax which is levied by the state governments in India on the movement of goods from one state to another. The state which receives the goods charges entry tax.”


In the past, the Supreme Court (the “SC”) has tackled many cases relating to the constitutional validity of entry tax levied by states. Most of the matters were ruled in the favour of the state. Over the years, the concept of “compensatory tax” evolved into a major factor in determining a state’s power to levy entry tax.   
Compensatory tax is a tax used as a regulatory measure for facilitation of free movement of trade, commerce and intercourse.
Similar matters today rely upon the decisions of the SC in “Atiabari Tea Co. Ltd. v. State of Assam & Ors. (AIR 1961 SC 232); Automobile Transport (Rajasthan) Ltd. etc. v. State of Rajasthan & Ors. (AIR 1962 SC 1406); M/s. Bhagatram Rajeev Kumar v. Commissioner of Sales Tax, M.P. and Ors. (1995 Supp [1] SCC 673); and State of Bihar and Ors. v. Bihar Chamber of Commerce and Page 27 27 Ors. (1996) 9 SCC 136” on the ground of the Compensatory tax theory. However, the authenticity of the aforementioned theory has come in serious question as it is not recognized by the Constitution of India (“Constitution”).
Taking into consideration the need to deliver a judgement on over 2000 lingering cases filed by various companies questioning the validity of entry tax charged by the states, the nine-member bench on November 11, 2016, in a majority ruling of 7:2 upheld the constitutional validity of the states to levy entry tax and passed an order of the referred matter with the following words:


Taxes simpliciter are not within the contemplation of Part XIII of the Constitution of India. The word ‘Free’ used in Article 301 does not mean “free from taxation”


The word ‘Free’ cannot be interpreted as absolute freedom/liberty or that any restriction on trade, commerce and intercourse is to be adjudged invalid. Taxation is a sovereign power assigned by the Constitution to the states and it may be exercised for the purpose of regulating an industry, commerce or any other activity. The state has a plenary and inherent power to do all things which promote the health, peace, morals, education and good order of the people. The power of the states to levy taxes can only be prohibited if expressly stated by the Constitution and not otherwise.


Only such taxes as are discriminatory in nature are prohibited by Article 304(a). It follows that levy of a non-discriminatory tax would not constitute an infraction of Article 301. 


The freedom understood in Article 301 of Part XIII of the Constitution is subject to non-discriminatory restrictions imposed by Parliament in public interest. This has been mentioned in Article 302 of Part XIII of the Constitution. Also, Article 304(a) of the Constitution states that non-discriminatory taxes may be imposed by the state on goods imported from another State or other States, if similar taxes are imposed on goods produced or manufactured in that State. The Article 302 clarifies the fact that levy of non-discriminatory tax is not a violation of Article 301.


Clauses (a) and (b) of Article 304 have to be read disjunctively. 


Clauses (a) and (b) of Article 304 of Part XIII of the Constitution deal with two distinct subjects and must, therefore, be understood to be independent of each other. Clause (a) is concerned only with levy of taxes on goods imported from other States, whereas Clause (b) talks about imposition of reasonable restriction in public interest. It is commonly understood that the levy of tax in Article 304(a) may or may not be partnered with the imposition of any restriction whether reasonable or unreasonable. There cannot any argument with regard to a state’s power to levy tax without imposing restrictions in Clause (b) and seeking the consent of the President in the proviso of Clause (b). Hence, the word ‘and’ between the clauses (a) and (b) cannot be interpreted as an obligation on the state legislature to compulsorily impose a tax and restriction together.     


A levy that violates 304(a) cannot be saved even if the procedure under Article 304(b) or the proviso there under is satisfied. 


This is closely related to point 3. which states that clauses (a) and (b) of Article 304 of Part XIII of the Constitution are to be read disjunctively. Hence, any activity such as in this case if an imposition violates Article 304 (a), it cannot be saved even if the procedure under Article 304 (b) or the proviso there under is satisfied.       


The compensatory tax theory evolved in Automobile Transport case and subsequently modified in Jindal Stripe Ltd. and Anr. v. State of Haryana and Ors. (2003) 8 SCC 60, has no juristic basis and is therefore rejected. 


The concept of compensatory tax theory is not recognized by the Constitution. Any tax which is levied is intended to be used for general public good, for running the governmental machinery and for provision of essential facilities to the people. Hence, there arises no question of a tax being non-compensatory in character. The fact that compensatory taxes fall outside Part XIII of the Constitution makes it difficult to apply in actual practice. Bearing in mind, the aforementioned reasons, it was decided to reject the compensatory tax theory.            


Decisions in Atiabari, Automobile Transport and Jindal cases (supra) and all other judgments that follow these pronouncements are to the extent of such reliance over ruled. 


The nine-member bench overruled the previous SC decisions in the above-mentioned cases in the aftermath of the rejection of the compensatory tax theory.        


A tax on entry of goods into a local area for use, sale or consumption therein is permissible although similar goods are not produced within the taxing state. 


Tax is charged for development of trade, commerce and industry and for creation and maintenance of infrastructure for facilitating the free flow of trade and commerce in a state. Therefore, it is permissible although similar goods are not produced within the taxing state.   


Test of non-discrimination 


Article 304 (a) frowns upon discrimination (of a hostile nature in the protectionist sense) and not on mere differentiation. Therefore, incentives, set-offs etc. granted to a specified class of dealers for a limited period of time in a non-hostile fashion with a view to developing economically backward areas would not violate Article 304(a). The question whether the levies in the present case indeed satisfy this test is left to be determined by the regular benches hearing the matters. 
Article 304 (a) of Part XIII of the Constitution which indicates the State’s right to impose any tax on goods disapproves discrimination of tax between the goods imported and the goods manufactured or produced within the state. However, a mere differentiation in the taxes charged with a view to developing economically backward areas would not be a violation of the article.
States are well within their right to design their fiscal legislations to ensure that the tax burden on goods imported from other States and goods produced within the State fall equally. Such measures if taken would not contravene Article 304(a) of the Constitution. The question whether the levies in the present case indeed satisfy this test is left to be determined by the regular benches hearing the matters. 
As long as the states ensure that the imposition of tax on goods imported from other states and on goods produced within the state are not discriminatory, the states would not violate Article 304 (a) of Part XIII of the Constitution and would retain their right to design fiscal legislations. 


Can an entire state be declared a 'local area'?


The questions whether the entire State can be notified as a local area and whether entry tax can be levied on goods entering the landmass of India from another country are left open to be determined in appropriate proceedings. 
A local area is an area regulated by a local authority such as a municipality, a district or a local board or a panchayat or some other body constituted by law for administering the governance of local affairs in any part of a state. Yet, there has been no conclusive inference as to whether a local area would refer to an entire state or some pockets within its territory and hence such a question is open to be determined in appropriate proceedings.

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