State’s Power to Impose Tax on Annual Turnover | Judgement Summary

On 4 November, the seven-judge Bench led by CJI Surya Kant, including Justices K.V. Viswanathan, S.V. Bhatti, Joymalya Bagchi, N.V. Anjaria, Arun Palli and V. Mohana held that the question of whether States can impose tax on annual turnover under Entry 54 of List II of the Seventh Schedule of the Constitution was rendered infructuous and unanimously disposed of the reference. 

In a 93-page long judgement, CJI Surya Kant wrote the majority opinion while Justice Viswanathan wrote a separate concurring opinion. Both opinions traced the history of the reference and held that there is no conflict between judgements which led to the reference. Further, both opinions underscored that the matters arising for adjudication were obsolete since the enactment of the Goods and Services Tax regime. 

Finally, the Bench clarified that the 1974 judgement in S. Kodar v State of Kerala [5-J] shall govern the question of impugned surcharges. 

Background of the reference 

In 1994, the Supreme Court heard a set of challenges against State enactments such as the Orissa Sales Tax Act, 1947 and Punjab Sales Tax Act, 1948 which empowered the State to impose a surcharge of 10 per cent on the total tax payable on every industrial unit whose gross turnover exceeds 10 lakhs. 

The appellants contended that the State does not have the power to impose a surcharge on annual turnover since that amounts to tax on “income” of the dealer and not tax on the sale and purchase of goods. Therefore, it falls outside the scope of Entry 54 of List II. The appellants challenged provisions like those under The Punjab Act, which made it compulsory for industrial units to pay the surcharge, even when they were exempted from the payment of sales tax. 

The States, however, argued that the nature of surcharge is nothing more than just the enhancement of sales tax on the sale and purchase of goods. Effectively, the State is competent to levy a surcharge on annual turnover. 

The lead matter came up for consideration before a two-judge Bench of Justices S.P. Bharucha and V.N. Khare. On 13 August 1998, the Bench took the view that the matter raised a substantial question of law as to the true nature of surcharge. The Bench further noted that Hoechst Pharmaceuticals Ltd. v State of Bihar (1983) [3-J] and India Cement Ltd. v State of Tamil Nadu (1990) [7-J] appeared to be conflicting decisions on the nature of surcharge and referred the question to a larger bench. 

The matter was placed before a Bench of five judges. On 6 October 1999, the Bench ordered that the Constitution Bench decision in S. Kodar v State of Kerala (1974) [5-J] must be reconsidered. 

What did the Conflicting Judgements suggest? 

The two judge bench of Justices Bharucha and Khare noted that the nature of surcharges in Hoechst Pharmaceuticals and India Cement were in conflict with each other. 

In Hoechst Pharmaceuticals, the three-judge Bench upheld the State’s power to levy surcharge under Entry 54 of List II, holding that the State Legislatures have plenary powers to tax sales and purchase of goods. The power to determine the rate of tax and how tax must be computed, assessed and recovered falls within the ambit of taxing powers of the State. 

In India Cement, an appellant who held mining leases was liable to pay royalty to the State Government under the Mines and Minerals (Regulation and Development) Act, 1957. The statute empowered every local panchayat union council to levy a local cess surcharge on the royalty. The question before the seven judge bench was whether the State Legislature was competent to levy a cess on royalty. Subsequently, the Court held that royalty is tax and therefore, cess on royalty was struck down as ultra vires. 

Broadly, the question of “royalty as tax” was considered in State of West Bengal v Kesoram Industries (2004) and finally, in Mineral Area Development Authority (MADA) v Steel Authority of India (2024), where a nine-judge bench held that royalty is not tax. The majority further held that the decision in India Cement that royalty is tax was set aside as incorrect. 

Issues and opinions of the Bench

Considering that India Cements was set aside by the Supreme Court, the seven-judge Bench considered whether the questions referred in 1999 still required adjudication. 

The Bench held that the doubts regarding the perceived conflict between Hoechst Pharmaceuticals and India Cement ceased to exist after MADA . Further, the judgement noted that Hoechst Pharmaceuticals and India Cement concerned levies of different characters—sales tax was the subject of the former while cess on royalty concerned the latter. Therefore, the Bench suggested that there was no real conflict between the two decisions. 

This turned the scrutiny on decisions in Hoechst Pharmaceuticals and S. Kodar. The Bench held that the two decisions are in harmony with each other on the power of the State to impose surcharge on annual turnover as well as the nature of the surcharge. The judgement noted that both decisions rested on the same foundation, holding that surcharge which is an increment to a sales tax is lawful if the sales tax is valid. 

The Bench relied on S. Kodar to determine the nature of surcharge, holding that the quantum of the additional tax imposed on sales tax would not alter its character, thereby rejecting the contention of the appellants that State Legislations are not competent to impose surcharge on annual turnover under Entry 54 of List II. 

Change in tax regime 

The disposal of the reference was attributed to the change in Constitutional entries and State enactments as the Value Added Tax regime was replaced by the Goods and Services Tax (GST) legislation. The Bench observed that Entry 54 of List II which conferred power on the State to tax sales and purchase of goods no longer exists after the 101st Constitutional Amendment. 

The Bench held that if the question arises regarding goods which continue to be taxed under Entry 54 of List II, it shall be governed by the judgement in S. Kodar. 

Conclusions

The opinion concluded in the following points: 

a. The decision in India Cement was set aside by MADA and the premise on India Cement being different, no subsisting decision conflicts with S. Kodar.

b. The decision in S. Kodar, which held that additional tax or surcharged computed as a percentage of sales tax is valid under Entry 54 of List II, continues to hold the field. 

c. With the Value Added Tax regime being replaced with the GST regime, the question of surcharge on sales tax does not survive for adjudication. 

Justice K.V. Viswanathan, in his concurrent opinion, held similar views, noting that additional tax, determined in reference to sales tax, levied is valid. Both opinions left questions concerning the Punjab General Sales Tax Act, 1948 and the Punjab Social Security Act, 2000 open for adjudication (Para 103). 

The Bench directed the matter to be placed before the appropriate regular bench(es) to be disposed of on their individual merits.