Entry Tax – Legality of levy & Industrial perspective

Entry 52, List II of the 7th Schedule of the Constitution enables the State Legislature to enact a law providing for levy of Entry Tax in a local area for consumption, use of sale therein. Entry 52 provides as follows :

“Taxes on entry of goods into a local area for consumption, use of sale therein.”

Reports of Finance Commission

Report of the Eleventh Finance Commission as presented in the Lok Sabha by the then Hon’ble Finance Minister Shri Yashwant Sinha on 27th July, 2000 under the Chairmanship of Prof. A.M. Khusro for 2000-05, mentioned in its report in Para 8.16, which is as under:-

“Octroi/Entry tax : Besides the property/house tax, octroi has been the major source of revenue for the municipalities and, in some States, even for the panchayats. Many States have, however, abolished octroi with a view to remove impediments to the physical movement of goods, though several other new barriers have been created. Some States have introduced a levy in lieu of octroi, usually called the entry tax, the net proceeds of which are transferred to the local bodies in the form of grant.”

The amount of Entry Tax levied by the State is pooled in the consolidated funds of State Government.

Second U.P. State Finance Commission (2001-06) in its report in para 14.111 has mentioned that Octroi used to be the most important source of revenue for Local Bodies. However, the collection of this octroi was full of deficiencies, malpractices and caused harassment. It also imposed negative economic costs due to impediments on movement of goods carriers leading to wastage of fuel and substantial time delays. A decision was taken at the national level to abolish octroi and compensate Local Bodies through appropriate mechanisms for loss of revenue caused. The U.P. Taxation Enquiry Committee, 1980 also recommended abolition of octroi.

Constitutional prohibitions

Article 301 of the Constitution of India states:

“Subject to the other provisions of this Part, trade, commerce and intercourse throughout the territory of India shall be free.”

The use of the words “throughout the territory of India” is significant, and cannot be under emphasized. Article 301 embodies the concept that India is one economic unit.

As observed by the Five-Judge Constitution Bench of the Supreme Court in Atiabari Tea Co. Ltd. vs. State of Assham, AIR 1961 SC 232 (Vide paragraph 34) :

“In drafting the relevant Articles of Part XIII the makers of the Constitution were fully conscious that economic unity was absolutely essential for the stability and progress of the federal polity which had been adopted by the Constitution for the governance of the country. Political freedom which had been won, and political unity which had been accomplished by the Constitution, had to be sustained and strengthened by the bond of economic unity. It was realized that in course of time different political parties believing in different economic theories or ideologies may come in power in the several constituent units of the Union, and that may conceivably give rise to local and regional pulls and pressures in economic matters. Local or regional fears or apprehensions raised by local or regional problems may persuade the State Legislatures to adopt remedial measures intended solely for the protection of regional interests without due regard to their effect on the economy of the nation as a whole. The object of Part XIII was to avoid such a possibility. Free movement and exchange of goods throughout the territory of India is essential for the economy of the nation and for sustained and improving living standards of the country. The provision contained in Article 301 guaranteeing the freedom of trade, commerce and intercourse is not a declaration of a mere platitude, or the expression of a pious hope of a declaratory character; it is not also a mere statement of a directive principle of State policy, it embodies and enshrines a principle of paramount importance that the economy unity of the country will provide the main sustaining force for the stability and progress of the political and cultural unity of the country. In appreciating the significance of these general considerations we may profitably refer to the observations made by Cardozo, J. in Charles H. Baldwin vs. G.A.F. Seeling, (1934) 294 U.S. 511 at page 523 : 79 Law Ed. 1032 at p. 1033, while he was dealing with the Commerce Clause contained in Article 1, section 8, Clause 3 of the American Constitution. ‘This part of the Constitution’ observed Cardozo, J. was framed under the dominion of a political philosophy less parochial in range. It was framed upon the theory that the people of the several states must sink or swim together and that in the long run prosperity and salvation are in union and not division.”

To understand the true purport of Article 301 we must understand that in feudal times when society was mainly agricultural there were small principalities and often there were customs or toll barriers at the boundaries of every small principality. This hampered the free flow of goods and was obstructing the growth of modern industry.
Modern industry being big as contrasted to handicraft industry, requires a large market. Hence, if there are restrictions on the free flow of goods from one part of the country to the other, growth of modern industry will not be possible. Our Founding Fathers in their wisdom realized the importance of having a large market so that a big and powerful modern industry can grow in the country. It is for this reason that they provided for Article 301 in the Constitution.

In Atiabari Tea Co. Ltd. (supra) the Supreme Court also observed:—

“On a careful examination of the relevant provisions of Part XIII as a whole as well as the principle of economic unity which it is intended to safeguard by making the said provisions, the conclusion appears to us to be inevitable that the content of freedom provided for by Article 301 was larger than the freedom contemplated by section 297 of the Constitution Act of 1935, and whatever else it may or may not include, it certainly includes movement of trade which is of the very essence of all trade and is its integral part. If the transport or the movement of goods is taxed solely on the basis that the goods are thus carried or transported that, in our opinion, directly affects the freedom of trade as contemplated by Article 301. If the movement, transport or the carrying of goods is allowed to be impeded, obstructed or hampered by taxation without satisfying the requirement of Part XIII the freedom of trade on which so much emphasis is laid by Article 301 would turn to be illusory. When Article 301 provides that trade shall be free throughout the territory of India primarily it is the movement part of the trade that it has in mind and the movement or the transport part of trade must be free subject of course to the limitation and exceptions provided by the other Articles of Part XIII. That we think is the result of Article 301 read with other Articles in Part XIII.”

Subsequent to the aforesaid decision in Atiabari Tea Co. Limited case (supra) a Seven-Judge Constitution Bench of the Supreme Court in Automobile Transport Ltd. vs. State of Rajasthan, AIR 1962 SC 1406 (Vide para 17) observed :

“Regulatory measures or measures imposing compensatory taxes for the use of trading facilities do not come within the purview of the restrictions contemplated by Article 301, and such measures need not comply with the requirements of the proviso to Article 304(b) of the Constitution.”

In the seven-Judge Constitution Bench decision of the Supreme Court in Automobile Transport Limited vs. State of Rajasthan (supra), it has been clearly stated that taxes are compensatory taxes which instead of hindering trade commerce and intercourse facilitate them by providing roads and maintaining the roads in good state of repairs. It has further been stated in paragraph 19 of the said decision that :

“a working test for deciding whether a tax is compensatory or not is to enquire whether the traders people are having the use of certain facilities for the better conduct of their business and paying not patently much more than what is required for providing the facilities.”

Hence, Entry 52 of List II is enabling provision under which the State Legislature can legislate on entry tax. This power flows from Article 246 of the Constitution. However, the power under Article 246 has to be read subject to the other Articles in the Constitution.

Hence, power to legislate under Article 246 of the Constitution has to be read as subject to Article 301 of the Constitution. It follows that the State Legislature cannot make a law which violates Article 301 of the Constitution. Hence, the scope of the legislative field contained in Entry 52 List II of the 7th Schedule has to be restricted and treated as subject to Article 301 and other Articles in the main body of the Constitution.

If follows that an entry tax cannot be imposed which violates Article 301 of the Constitution, despite Entry 52 of List II.

Jindal Stainless Ltd. & Anr. vs. State of Haryana & Ors, JT 2006 (4) SC 611 : 145 STC 594 :

The Constitution Bench of the Apex Court after considering Automobile Transport has reversed the judgment in case of M/s. Bhagatram Rajeevkumar vs. Commissioner of Sales Tax, M.P. & Others, (1995) Suppl. (1) SCC 673 and State of Bihar vs. Bihar Chamber of Commerce, (1996) 9 SCC 136 and laid down the parameters of judicially evolved concept of compensatory tax and has held as under :—

“39. On the other hand, a fee is based on the “principle of equivalence”. This principle is the converse of the “principle of ability” to pay. In the case of a fee or compensatory tax, the “principle of equivalence” applies. The basis of a fee or a compensatory tax is the same. The main basis of a fee or a compensatory tax is the quantifiable and measurable benefit. In the case of a tax, even if there is any benefit, the same is incidental to the Government action and even if such benefit results from the Government action, the same is not measurable. Under the principle of equivalence, as applicable to a fee or a compensatory tax, there is an indication of a quantifiable data, namely, a benefit which is measurable.

40. A tax can be progressive. However, a fee or a compensatory tax has to be broadly proportional and not progressive. In the principle of equivalence, which is the foundation of a compensatory tax as well as a fee, the value of the quantifiable benefit is represented by the costs incurred in procuring the facility/services which costs in turn become the basis of reimbursement/ recompense for the provider of the services/facilities. Compensatory tax is based on the principle of “pay for the value”. It is a sub-class of “a fee”. From the point of view of the Government, a compensatory tax is a charge for offering trading facilities. It adds to the value of trade and commerce which does not happen in the case of a tax as such. A tax may be progressive or proportional to income, property, expenditure or any other test of ability or capacity (principle of ability). Taxes may be progressive rather than proportional. Compensatory taxes, like fees, are always proportional to benefits. They are based on the principle of equivalence. However, a compensatory tax is levied on an individual as a member of a class, whereas a fee is levied on an individual as such. If one keeps in mind the “principle of ability” vis-à-vis the “principle of equivalence”, then the difference between a tax on one hand and a fee or a compensatory tax on the other hand can be easily spelt out. Ability or capacity to pay is measurable by property or rental value. Local rates are often charged according to ability to pay. Reimbursement or recompense are the closest equivalence to the cost incurred by the provider of the services/facilities. The theory of compensatory tax is that it rests upon the principle that if the Government by some positive action confers upon individual(s), a particular measurable advantage, it is only fair to the community at large that the beneficiary shall pay for it. The basic difference between a tax on one hand and a fee/compensatory tax on the other hand is that the former is based on the concept of burden whereas compensatory tax/fee is based on the concept of recompense/ reimbursement. For a tax to be compensatory, there must be some link between the quantum of tax and the facility/services. Every benefit is measured in terms of cost which has to be reimbursed by compensatory tax or in the form of compensatory tax. In other words, compensatory tax is a recompense/ reimbursement.”

In the context of Article 301, therefore, compensatory tax is compulsory contribution levied broadly in proportion to the special benefits derived to defray the costs of regulation or to meet the outlay incurred for some special advantage to trade, commerce and intercourse. It may incidentally bring in net-revenue to the Government but that circumstance is not an essential ingredient of compensatory tax.

Applying the above tests/parameters, whenever a law is impugned as violative of Article 301 of the Constitution, the Court has to see whether the impugned enactment facially or patently indicates quantifiable data on the basis of which the compensatory tax is sought to be levied. The Act must facially indicate the benefit which is quantifiable or measurable. It must broadly indicate proportionality to the quantifiable benefit. If the provisions are ambiguous or even if the Act does into indicate facially the quantifiable benefit, the burden will be on the State as a service/facility provider to show by placing the material before the Court, that the payment of compensatory tax is a reimbursement/recompense for the quantifiable/measurable benefit provided or to be provided to its payer(s). As soon as it is shown that the Act invades freedom of trade it is necessary to enquire where the State has proved that the restrictions imposed by it by way of taxation are reasonable and in public interest within the meaning of Article 304(b).

Apex Court Order — Remitting the issue

A Division Bench of Hon’ble Mr. Justice Arijit Pasayat and Hon’ble Mr. Justice S.H. Kapadia of the Apex Court, when cases were again listed before their Lordships’ (referring to aforequoted paras of the Constitutional Bench judgment) passed judgment and order dated 14-7-2006 observing that basic issue in the cases revolved around concept of ‘Compensatory Tax’ but since the concerned High Courts appears to have not examined the matter in proper perspective (since in some cases relevant data was not placed before concerned High Courts), parties may within two months of receipt of said judgment place the same in their concerned Writ Petitions within two months and concerned High Courts should decide the said basic issue (whether impugned ‘levy’ under the Act was compensatory in nature’?) within five months from the date of receipt of their judgment.

High Courts judgments

Judgments of High Courts of Kerala, Allahabad, Patna, Guwahati Jharkhand, Punjab & Haryana and Rajasthan rendered in the light of judgment of the Hon’ble Supreme Court in the case of Jindal Stainless Limited (supra), have declared the respective Entry Tax Acts of their State as illegal and invalid being not compensatory.

The Kerala High Court in its judgment dated 18-12-2006 in M/s. India Gateway Terminal Pvt. Ltd. vs. Intelligence Officer and Another [W.A. No. 2267 of 2005 (B)], dealt with the question of validity of Kerala Tax on Entry of Goods into Local Areas Act, 1994 in the context of directions of the Hon’ble Supreme Court in Jindal Stainless Limited and another vs. State of Haryana and Others, (2006) 7 SCC 271. The said provisions had been earlier upheld by a Division Bench of the High Court in Rajan vs. State of Kerala, (1995) 2 KLT 369. A different view was, however, taken in a later judgment in Father William Fernandez vs. State of Kerala & Others, 115 STC 591. On behalf of the State, affidavit was filed showing the amount collected from entry tax and capital expenditure on roads and bridges. The Court held that the Act did not indicate any benefit which was either quantifiable or measurable and, thus, compensatory character of tax was not self-evident from the Act. It was further held that the Act was for the purpose of augmenting general revenue. Maintenance of roads, providing of bridges etc. could no be held to be compensatory to meet outlay incurred for special advantage to trade, commerce and intercourse. The facilities were incidental. Expenses on roads, bridges were met from the general fund of the revenue and the said facilities were enjoyed not only by the persons bringing notified goods subjected to entry tax but also others. There is no nexus of tax with the utilization of services. Finally, it was concluded as under :—

“22. We, therefore, hold that the levy of entry tax on goods imported from other States to the State of Kerala and from abroad is not compensatory in nature since the State Government could not discharge its burden by placing materials before Court that payment of levy of entry tax is reimbursement/recompense for the quantifiable/measurable benefit provided or to be provided to the petitioners. The impugned Act imposing entry tax cannot be said to be specifically meant for facilitating trade, commerce and intercourse, but is raised for augmenting the general revenue of the State. We, therefore, hold that the demand and collection of entry tax under the Kerala Tax on Entry of Goods into Local Areas Act, 1994 is illegal, unauthorized and violative of Article 301 of the Constitution of India. Original Petitions are allowed as above and the levy and demand notices issued would stand quashed. “

The Allahabad High Court in its judgment dated 8-1-2007 in M/s. Indian Oil Corporation Limited vs. State of Uttar Pradesh and Others, Civil Misc. Writ Petition No. 251 of 2003, considered the question of validity of U.P. Tax on Entry of Goods Act, 2000, with reference to the contention that the same was violative of Articles 301 and 304 of the Constitution. The State filed an affidavit in the light of order of the Hon’ble Supreme Court in Jindal Stainless Limited, (2006) 7 SCC 271 to show that the tax was compensatory. In the affidavit, the State give figures of tax received and funds allocated to local bodies and expenditure for development works on construction and maintenance of roads and bridges. Reliance was also placed on provisions contained in Part IX and IX-A of the Constitution substituted by 73rd and 74th amendment read with Eleventh and Twelfth Schedules to the Constitution. Reference was also made to report of the State Finance Commission regarding allocation of funds to local bodies and to report of Eleventh Finance Commission suggesting taxes for augmenting consolidated funds of the States. It was observed by the Court that since the amount of revenue earned from the entry tax was pooled in the consolidated fund and utilized under the budgetary allocation and also utilized to make up budgetary deficit of local bodies, there was no occasion to probe reasonableness or proportionality of the same. It was observed that the State failed to pinpoint or establish the specific/additional service/facility provided to payers of the tax.

The Patna High Court in its judgment dated 9-1-2007 in Harinagar Sugar Mills Limited vs. The State of Bihar and Others, Civil Writ Jurisdiction Case No. 2739 of 2003 also considered the question of validity of levy of Bihar Entry Tax under the 1993 Act, in the light of the directions of the Hon’ble Supreme Court in Jindal Stainless Limited, (2006) 7 SCC 271. The State relied upon amendments made to the Act providing for creation of Bihar Trade Development Fund. It was, however, observed that after 2006 Amendment, the tax could be held to be compensatory as the proceeds of levy were to be used exclusively for development of trade and industry in the State of Bihar. The conclusions reached were as under :

1. “The levy under the Parent Act of 1993, before its amendments, was not compensatory in character and was, therefore, violative of Article 301 of the Constitution.

2. The Parent Act of 1993, before its amendments, was nevertheless saved by virtue of Article 304(b) of the Constitution and the decision in Bihar Chamber of Commerce to that extent remains subsisting till date.

3. The amendments introduced in the Act by amending Acts 10 of 2001 and 9 of 2003 were bad because the former made the Act violative of Article 304(a) of the Constitution and further because both the amendments were made without the previous sanction of the President.

4. The introduction of imported goods within the definition of ‘Entry of Goods’ was bad for being retrospective as also for want of the Presidential sanction/assent.

5. After the 2006 Amendment the levy under the Act acquired the nature of a compensatory tax and the Act in its present form is a valid piece of legislation.”

In light of the above discussions, the two cases are fit to be allowed because they relate to the period 2001-06. But I would refrain from making any order or direction in that regard since the matter is already pending before the Supreme Court.

The two cases are thus disposed of as directed by the Supreme Court in Jindal Stainless Ltd.”

The Guwahati High Court in its judgment dated 17-11-2006 in ITC Limited vs. The State of Assam (WP (C) No. 2650 of 2005, considered the issue in a batch of nine petitions challenging the validity of Assam Entry Tax Act, 2001. It was held that the entry tax was not in the nature of compensatory tax. The same had been levied to broaden the tax base and to obtain additional tax resources. The data produced by the State only showed that certain amounts had been allocated to the local bodies but there was nothing to show that any specific facilities were provided to the traders or importers of the goods. The grants included grants for expenses incurred in local areas not only for facilities for traders or importers of the goods but also to public at large.”

Jharkhand High Court in its judgment dated 14-8-2006 in The Tata Iron & Steel Company Ltd. vs. The State of Haryana, W.P. (T) No. 5354 of 2004 examined the issue with reference to the provisions of Bihar Taxes on Entry of Goods into Local Areas for Consumption, Use or Sale thereof Act, 1993 (Act 16 of 1993) as adopted by the State of Jharkhand vide notification dated 15-12-2000 and as amended vide Jharkhand Tax on Entry of Goods into Local Areas for Consumption, Use or Sale thereof (Amendment) Ordinance, 2001 and held that the levy therein was not compensatory.

Punjab & Haryana High Court on 14-3-2007 in Writ No. 6630 of 2000 – Jindal Strips Limited vs. State of Haryana while declaring the Entry Tax Act as invalid and void held in paras 29 & 30 as follows :—

“29. We find merit in the contention raised on behalf of the petitioners. The levy is not to meet the cost of any specific facility already provided or planned to be provided. The parameters clearly laid down in Jindal Stainless Limited (paras 16 and 41 to 45) are that compensatory tax represent the costs incurred in procuring facilities/services on the principle of “pay for value”. It is a charge for offering trade facilities. It adds to value of trade and commerce. It is based on the principle of equivalence. It must have a broad proportion to the benefit derived to defray the cost of regulation or to meet the outlay incurred for some special advantage to trade and commerce and intercourse. The impugned levy initially was meant to be for assistance to local areas for their development generally and the amendment brings about only a superficial change in the language while retaining the basic character of the levy as a source for raising general development. In this view of the matter, we are unable to hold that the facial test is met. Mere specification of the 60% of the amount being in line with judgments dealing with the levy of fee is of no consequence when the very subject matter of utilization cannot be treated as any special direct or exclusive service or benefit of the payer of the tax.

30. In view of above, the data given by the State in respect of the amount spent does not stand scrutiny. As rightly pointed out by learned counsel for the petitioners, the expenditure incurred is 17% o the total collection and the expenditure is far less than the collection of much more amount under other statutes levying compensatory taxes to cover the cost of at least some of the very same services. The burden of proof on the State cannot be held to have been discharged.”

Rajasthan High Court in Writ No. 21 of 2002 – Dinesh Pouches Ltd. vs. State of Rajasthan decided on 20-8-2007 has declared the provisions of Rajasthan Tax on Entry of Goods in the Local Area Act as being not compensatory in nature.

Industrial perspective

For levy of Entry tax on trade and industry, State must satisfy the Court that for the special benefits, which the traders are claimed to have been provided with, the traders are not paying “patently much more than what is required for providing facilities”. This test has been adhered even in Jindal Stainless Ltd. (supra). The State Government ought to have show as to what trading facilities it has really provided to the traders, what expenses are incurred for providing such facilities and how much amount, realized from the imposition of the entry tax, is being utilized for providing the trading facilities so that this Court could feel satisfied that the traders are paying, for the facilities, if any, provided to them, patently not much more than what is required for providing the facilities.

Before the coming of modern industry society was mainly agricultural and there were small principalities and there was very little movement of goods from one area to another. The goods produced were mainly for self consumption by the producers (tenant farmers and petty artisans) and were not mainly commodities (i.e., goods for sale and not for self consumption).

In contrast, today almost all goods which are produced by modern industry are commodities, that is, they are meant for sale and not for self consumption. Modern industry requires a large market and it cannot develop if the country is fragmented into small economic units. If one reads the history of Western Europe before the industrial Revolution, one will find that countries like France, Germany, Italy, etc. were fragmented into small principalities, each principality having its customs or toll barriers which obstructed the free flow of goods from one principality to another. Thus, before the French Revolution of 1789 in France there were a large number of principalities having toll barriers and there were toll taxes (similar to Entry Tax) after every 30 or 40 km. Throughout the territory of France. Similar was the condition in Germany which was fragmented into over 300 principalities before its unification under Bismack. This led to obstruction to the growth of modern industry, and hence was abolished by the enlightened leaders of those countries. The result was that thereafter there was rapid growth of industry and commerce in those countries.

Moreover, it is rapid industrialization and growth of modern big industry which alone can generate the wealth which we require for providing for the welfare of our people, for setting up modern schools, engineering colleges, hospitals, scientific institutes, etc. This money can only be generated if we set up a big and powerful industry and that is possible only if such industry has a large and vast market.