Quest

Entry Tax – Changing Scenario of Compliance
by State Legislature for its validity

Earlier Octroi was levied by different Municipal Boards on the entry of goods into the local area for the consumption, use or sale therein.

The 10th Finance Commission for 1999-2000 set up by the Central Government the State Urban Local Bodies were given grant-in-aid for their development programmes wherein building of drains, sanitation, drainage, etc. were included.

The decision was taken at the national level to abolish octroi and compensate local bodies through appropriate mechanism for loss of revenue caused.

The report of 11th Finance Commission has presented by the then Finance Minister Shri Yashwant Sinha on 27-7-2000 in which a reference was made in paragraph 8.16(b) that

“The octroi was the major source of revenue which have been abolished with a view to remove impediments to the vehicle movement of goods though several other new barriers have been created. Some States have introduced a levy in lieu of octroi, usually the entry tax, the net proceeds which are transferred to the local bodies in the form of grant.”

The said report further mentioned that

"While we do not advocate reintroduction of octroi, we do feel that there is a need for replacing it with a suitable tax that is buoyant and can be collected by the local bodies.”

The legislative power of the State to make any law under Article 246 read with Entries in List-2 are subjected to two limitations;

  1. Fundamental rights (Part-II) of the Constitution

  2. Trade Commerce and intercourse within the territory of India (Part-XIII) of the Constitution.

The States can exercises the power to enact the Entry Tax under Entry 52 of List 2 (State list) which provides as follows :

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

The States cannot exercise its legislative power in a manner which would transgress the constitutional limitation, mentioned above, especially Article 301 which guarantees freedom of trade, commerce and intercourse throughout the country.

About 47 years ago Hon’ble Apex Court has visualised the present political scenario of multi-parties Government when the constitution bench of the Supreme Court in Atiabari Tea Company Ltd., vs. State of Assam AIR 1961 SC 232 in paragraph 34 has held as follows :-

“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 conceivable 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 that 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 national and for sustaining 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 economic unity of the country will provide the main sustaining force for the stability and progress of the political and cultural unit of the country.

I am of the view that Modern industry being big as contrasted to feudal 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 of the Constitution”.

In Automobile Transport Co. Ltd. vs. State of Rajasthan AIR 1962 SC 1406 the Constitution bench of seven judges of the Supreme Court explained the concept of compensatory tax with reference to Article 301 of the Constitution of India. In that connection it was held in paragraph 19 as follows:-

“……..It seems to us that a working test for deciding whether a tax is compensatory or not is to enquire whether the trades 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. It would be impossible to judge the compensatory nature of a tax by a meticulous test and in the nature of things that cannot be done.”

In spite of the aforesaid Constitution bench decisions Division Benches of Supreme Court in the case of Bhagat Ram Rajeev Kumar vs. Commissioner of Sales Tax 1955 Supp (1) SCC 673 and State of Bihar vs. Bihar Chamber of Commerce 1996 (9) SCC 136 has held that even if there is substantial or even some link between the tax and the facilities extended to such dealers directly or indirectly the levy cannot be impugned as invalid.

In the case of Indian Oil Corporation Ltd. vs. State of U.P. reported in 2004 UPTC 170 Hon’ble Mr. Justice M. Katju as he then was in the Allahabad High Court has noticed the fact that the smaller benches of the Hon’ble Supreme Court in Bhagat Ram Rajeev Kumar vs. Commissioner of Sales Tax and State of Bihar vs. Bihar Chamber of Commerce cannot be followed in view of the settled decision of the larger bench regarding the compensatory nature of tax and accordingly after relying upon the seven judges Constitution bench decision in the case of Automobile Transport Co. Ltd., vs. State of Rajasthan has declared U.P. Tax on Entry of Goods Act, 2000 as violative of Articles 301 and 304 of the Constitution of India.

It was held in the seven judge Constitution bench decision of the Supreme Court in Automobile Transport Co. Ltd., 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 trades 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

The amounts granted by the State Government to the local bodies and Panchayatiraj Institutions have no co-relation, what to say of broad co-relation, with the amounts realized as entry tax. The amount realized as entry tax can be used for any purpose and not merely for facilitating trade and commerce.

Since entry tax was enacted in U.P. for augmenting the revenue of the State the same was declared as invalid and void.

The Statement of Objects and Reasons of the Act clearly discloses that the impugned Act was enacted to augment the general revenue of the State and not for facilitating trade and commerce.

Various High Courts followed the decision of Bhagat Ram Rajeev Kumar vs. Commissioner of Sales Tax and State of Bihar vs. Bihar Chamber of Commerce while upholding the Entry Tax Act.

It is only on 26-9-2003 that the matter was referred to Constitution bench by two-judge bench of the Supreme Court for deciding the correctness of the judgment of Bhagat Ram Rajeev Kumar vs. Commissioner of Sales Tax and State of Bihar vs. Bihar Chamber of Commerce.

Constitution Bench decision of Jindal Strips

In the case of Jindal Strips Limited and Another vs. State of Haryana and Others, [2008] 12 VST 149 (P & H), [2006] 145 STC 555 (SC), [2006] 4 JT SC 611 & 2006 (7) SCC 241:

The Constitution bench laid down the distinction between the tax, fee and compensatory tax as follows :-
Tax is levied as a part of common burden. The basis of a tax is the ability or the capacity of the tax-payer to pay. The principle behind the levy of a tax is the principle of ability or capacity. In the case of a tax, there is no identification of a specific benefit and even if such identification is there, it is not capable of direct measurement. In the case of a tax, a particular advantage, if it exists at all, is incidental to the States’ action. It is assessed on certain elements of business, such as, manufacture, purchase, sale, consumption, use, capital, etc., but its payment is not a condition precedent. It is not a term or condition of a licence. A fee is generally a term of a licence. A tax is a payment where the special benefit, if any, is converted into common burden.

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.

A tax can be progressive. However, a fee or 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.

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 the 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 according 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 a 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 inter course. It may incidentally bring in net revenue to the Government but that circumstance is not an essential ingredient of compensatory tax.

Since the entry tax has been imposed on the goods which are brought into the local area for consumption, use or sale. It affect the activity like trade and commerce as the criterion of its operation and if the effect of the operation of the enactment is to impede trade and commerce then Article 301 is violated.

Accordingly, in the changing scenario of the compliance for justifying the entry tax one 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 or the State must produce the data and materials for justifying the same on the basis of Constitution Bench decision of the Jindal Strips.

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 not 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 whether 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).

After laying down the principle regarding compensatory tax, Hon’ble Supreme Court on 14th July, 2006 have remitted the basic issues to the various High Courts observing that basic issue in the cases revolved around concept of “compensatory tax” but since the concerned High Courts appeared to have not examined the matter in proper perspective (since in some cases relevant data was not placed before concerned High Courts), parties may place the same in their concerned writ petitions before the High Court.

State of U.p.

In the case of Indian Oil Corporation Limited vs. State of U.P. and Others, [2007] 10 VST 282 (All), the Hon’ble Allahabad High Court has held that the Entry Tax Act of U.P. is not compensatory as there is not even an iota of evidence/material on record to give required data/statistics to prove/establish that the amount collected as “tax” and its expenditure on providing additional/specific advantage/facility provided to trade/s in particular mentioned under the Schedule of the Act. In absence of such data it is not possible for this Court to hold that “entry tax” is “compensatory tax”.

State of Jharkhand

The Jharkhand High Court in its judgement dated August 14, 2006 in Tata Iron & Steel Company Ltd. vs. State of Jharkhand [W.P.(T) No. 5354 of 2004] reported in [2007] 6 VST 587, examined the issue with reference to the provisions of the Bihar Taxes on Entry of Goods into Local Areas for Consumption, Use or Sale therein Act, 1993 (Act 16 of 1993) as adopted by the State of Jharkhand vide notification dated December 15, 2000 and as amended vide Jharkhand Tax on Entry of Goods Into Local Areas for Consumption, Use or Sale therein (Amendment) Ordinance, 2001 and held that the levy therein was not compensatory.

In the present case, the respondents have not been able to show that the Bihar Tax on Entry of Goods into Local Areas for Consumption, Use or Sale therein Act, 1993, as adopted by the State of Jharkhand vide Notification dated December 15, 2000 and amended vide Jharkhand Tax on Entry of Goods into Local Areas for Consumption, Use or Sale thereof (Amendment) Ordinance, 2001 (Jharkhand Ordinance 2 of 2002), is based on the “principle of equivalence”. No basis has been shown to levy entry tax in the nature of compensatory tax to find out quantifiable and measurable benefits. Nothing has been indicated either in the “Bihar Tax on Entry of Goods into Local Areas for Consumption, Use or Sale therein Act, 1993”, adopted by the State of Jharkhand, or in the “Jharkhand Tax on Entry of Goods into Local Areas for Consumption, Use or Sale thereof (Amendment) Ordinance, 2001 (Jharkhand Ordinance 2 of 2002)” showing any quantifiable data or a benefit which is measurable. Thus, in our considered view the entry tax levied under the Bihar Tax on Entry of Goods into Local Areas for Consumption, Use or Sale therein Act, 1993, as adopted by the State of Jharkhand and amended by Jharkhand Tax on Entry of Goods into Local Areas for Consumption, Use or Sale thereof (Amendment) Ordinance, 2001 (Jharkhand Ordinance 2 of 2002), is, thus, not based on the principle of equivalence and is not compensatory in nature.

State of Kerala

In the case of Thressiamma L. Chirayil vs. State of Kerala and Another, reported in [2007] 7 VST 293 (Ker) it was held that

Kerala Entry Tax Act facially or patently has not indicated any benefit which is either quantifiable or measurable. If the provision of the Act does not indicate facially the quantifiable benefit, burden is on the State as a service/facility provider to show by placing the materials before the Court that the payment of compensatory tax is a reimbursement/recompense for the quantifiable/ measurable benefit provided or to be provided to the payer. We have already found that the compensatory character of tax is not self-evident from the Kerala Entry Tax Act.

Maintaining of roads, bridges, etc., and promotion of SSI units, etc. are generally met from the general funds or revenue. Whether goods are transported into the State from outside the State or abroad the State has got a duty to provide those facilities, like roads, bridges, etc., which is being enjoyed not only by persons who bring goods notified for levy of entry tax but also others. In our view, there is absolutely no connection or nexus with the collection of entry tax and its utilization for the benefit of traders/manufacturers from whom such tax is collected.

Unless and until State discharges its burden by placing materials before Court that payment of compensatory tax is  reimbursement/recompense, quantifiable/measurable benefit provided or to be provided to the payers or there is any broad correlation between the entry tax being realised and the services rendered, it cannot sustain levy of entry tax. We are of the view, State has not discharged its burden by providing quantitative data on the basis of which compensatory tax is sought to be levied and the working test laid down in Automobile Transport’s case, AIR 1962 SC 1406, Jindal Stainless Ltd.’s case, [1006] 145 STC 544 (SC) ; [2006] 7 SCC 241 or Vijayalakshmi Rice Mills’ case, [2006] 147 STC 609 (SC) : [2006] 6 SCC 763 is not satisfied in these cases for levying entry tax.

We therefore hold that the levy of entry tax on goods imported from other State 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.

State of Assam

The Guwahati High Court in its judgment dated November 17,2006 in ITC Limited vs. State of Assam, [W.P. (C) No. 2650 of 2005 – (2007) 9 VST 250 (Guwahati)] , considered the issue in a batch of nine petitions challenging the validity of the 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 the public at large.

State of Bihar

The Patna High Court in its judgment dated January 9, 2007 in Harinagar Sugar Mills Limited vs. State of Bihar (Civil Writ Jurisdiction case No.2739 of 2003 – [2007] 10 VST 140), also considered the question of validity of levy of Bihar entry tax under the 1993 Act, in the light of the directions o 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 held that the entry tax could not be treated as compensatory inasmuch as money collected went to the Consolidated 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.

State of Punjab & Haryana

A perusal of statutory provisions shows that the levy of tax is on entry of goods into a local area for consumption, use or sale and the tax is payable by the importer with reference to value of goods at a specified rate. The tax collected is to be distributed by the State Government among the local bodies. The same is to be utilized for development facilitating free-flow of trade and commerce on infrastructural facilities such as roads, bridges, culverts, sewerage, drainage, sanitation, waste-management, electricity, drinking water and other infrastructural facilities. At least 60 per cent of the amount is to be utilised. The board is to ensure balance development of the local areas and recommend allotment of proceeds of tax are not more than the amount actually required for development of local areas.

Waste-management, sanitation, drainage, water, electricity may be unconnected with the facilities for the purpose of trade. The said facilities may be made before general development of the State, though termed as facilitating trade and commerce. There is no separate earmarking of the facilities planned for the traders or facilities generally for water supply, hygiene, sanitation, waste-management, etc.

The defence on behalf of the State is that the statutory provisions for constituting a Board and requiring the Board to ensure that the tax collected was not much more than the amount actually required and provision for utilizing at least 60 per cent for development facilitating free-flow of trade and commerce of the payers of the tax was not enough to meet the facial test, if the payers of the tax are taken to be the ultimate payers to whom the burden was passed on, which include farmers, transporters and consumers.
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.

Levy of Entry Tax on Entry of Motor Vehicles into Local Areas Act was challenged before the Madras High Court and Hon’ble Madras High Court on 10-7-2007 while holding the State Act as not compensatory has held as follows :-

State of Tamil Nadu

In the case of R. Gandhi vs. State of Tamil Nadu & Others [2008] 13 VST 390 (Mad) the Madras High Court has held that

There is a clear cut distinction between the general taxing power of the State and the levy of compensatory tax. For a law to be compensatory there has to be a rational nexus between the levy and the services provided. The essence of compensatory tax is that the services rendered or facilities provided should be more or less commensurate with the tax levied. Services provided will have a direct co-relation with the trade. The main basis of compensatory tax is the quantifiable and measurable benefit represented by the cost incurred in procuring the facilities/services. The cost in turn becomes the basis of reimbursement/recompense for provider of services/facilities. The compensatory tax is a charge for offering trade facilities and they are based on the principle of equivalence. In the case of petitioners the materials produced by the State show that substantial amounts have been spent on the construction and maintenance of roads and bridges. Applying the above stated test it cannot be said that maintaining of roads, providing bridges, etc. are compensatory in nature so as to constitute special advantage to trade, commerce and intercourse. Even otherwise, a welfare State is bestowed with the responsibilities of providing good roads and bridges for the benefit of the tax-paying citizens and hence to contend that the impugned levy is being raised only for the said purpose is not justified. Maintenance of roads, bridges, etc. are generally met from the general funds or revenue. Whether goods are transported into the State or outside State or abroad, the State has got a duty to provide facilities like roads, bridges, etc. which are being enjoyed not only by the persons who bring the goods notified for levy of entry tax, but also by others. Further as per the Statement of Objects and Reasons the Act has been enacted with a view to curb the evasion of sales tax on the sale of motor vehicles which are purchased outside the State and brought into the State and the tax thus recovered under the Act is liable to be adjusted with the general sales tax payable under the Tamil Nadu Tax on Entry of Motor Vehicles into Local Areas Act, 1990 is not compensatory in nature.

Even the Andhra Pradesh Tax on Entry of Goods into Local Areas Act, 2001 was declared to be unconstitutional by the Andhra Pradesh High Court has held as follows:–

State of Andhra Pradesh

Andhra Pradesh High Court in the case of Sree Rayalaseema Alkalies and Allied Chemicals Limited vs. State of Andhra Pradesh and Others [2008] 13 VST 15(AP) has held that

For one to justify, a particular tax levied to be compensatory in nature, it is essential that there should be direct and intricate relationship between the collection of tax and its intended expenditure. The broad and generalized statements mentioned by the State Government, as were noticed supra by us, are ally representing or corresponding to the basis and fundamental obligations of any Government, which they owe to their citizens. They are not special features specific to cater to the needs of the people indulging in trade or commerce.

State of Rajasthan

In the State of Rajasthan the Jodhpur Bench has held in the case of Dinesh Pouches that the Rajasthan Entry Tax Act is not compensatory. However, a different view was taken by the Jaipur Bench whereupon the matter was referred to larger Bench and is pending before the Full Bench of the High Court.

Conclusion

To justify the test of quantifiable and measurable benefits in order to justify the realization of entry tax it has to be the reimbursement or recompense to the cost incurred by the provider for the service/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.

In these circumstances, I am of the view that construction of roads, culverts and bridges or providing health care facilities or rest-houses for the transport operators on the waysides are not exclusively intended or meant for promoting any class, or even generally, the trade or commerce. Such basic and essential infrastructural facilities are also liable to be put to use by all others as well. In that respect, provision of such facilities like goods motorable roads, illumination of streets or provision of parks or gardens cannot be rolled up and presented as the “specific end objectives” of the intended promotion of the interests of tradesmen or businessmen. The essential link between the infrastructure or facility or service, which is directly or even indirectly held to promote the cause of trade or commerce shall be missing to justify the levy of Entry Tax.