Royalty Calculation on Minerals: Supreme Court Examines Compounding Effect in Kirloskar Ferrous Industries vs. Union of India (2024)

Introduction

Date of the Judgment: November 7, 2024

Citation: 2024 INSC 848

Judges: Dr. Dhananjaya Y. Chandrachud, CJI, J.B. Pardiwala, J., Manoj Misra, J.

Is it fair to calculate royalty on minerals by including previous royalty payments in the base calculation? The Supreme Court of India recently addressed this complex question in a case involving Kirloskar Ferrous Industries Limited. The core issue revolved around whether the current method of calculating royalties, as stipulated by the Mineral Concession Rules, 2016 and the Mineral Conservation and Development Rules, 2017, leads to an unfair compounding effect. The petitioners argued that this method, which includes prior royalty payments in the calculation of the average sale price, effectively results in paying royalty on royalty, a practice they deemed arbitrary and unconstitutional. The three-judge bench of the Supreme Court, comprising of Dr. Dhananjaya Y. Chandrachud, CJI, J.B. Pardiwala, J., and Manoj Misra, J., heard the arguments and issued directions.

Case Background

Kirloskar Ferrous Industries Limited, the first petitioner, is a mining leaseholder involved in extracting pig iron and manufacturing related products in Karnataka. The second petitioner is a shareholder in the first company. The respondents include the Union of India, represented by the Secretary, Ministry of Mines, and the Indian Bureau of Mines. The dispute arose from the method of calculating royalty on minerals, as per the Mines and Minerals (Development and Regulation) Act, 1957 (MMDR Act). This act mandates that mining leaseholders pay royalty on minerals extracted or consumed from their leased areas. The royalty rates are specified in the Second Schedule of the MMDR Act and can be revised by the Central Government every three years.

The Mineral Concession Rules, 1960 (MCR, 1960) were initially in place, which were later replaced by the Mineral Concession Rules, 2016 (MCR, 2016). Rule 64D of the MCR, 1960, stated that royalty for non-atomic and non-fuel minerals would be based on state-wise sale prices published by the Indian Bureau of Mines. However, the 2015 Amendment Act introduced contributions to the District Mineral Foundation (DMF) and the National Mineral Exploration Trust (NMET), calculated as percentages of the royalty paid. The MCR, 2016, and the Mineral Conservation and Development Rules, 2017 (MCDR, 2017), further refined the calculation of royalty. The petitioners contested the explanations in these rules, which stipulate that royalty, DMF, and NMET payments are not deducted when computing the ‘sale value’ of minerals, leading to the alleged compounding effect.

Timeline

Legal Framework

The case is primarily governed by the Mines and Minerals (Development and Regulation) Act, 1957 (MMDR Act). Section 9 of the MMDR Act mandates the payment of royalties for any mineral removed or consumed from a leased area. Specifically, Section 9(1) and 9(2) require leaseholders to pay royalties at rates specified in the Second Schedule of the Act. Section 9(3) empowers the Central Government to amend the Second Schedule to enhance or reduce royalty rates, but not more than once every three years.

Section 13 and 18 of the MMDR Act authorize the Central Government to frame rules for regulating mineral concessions and for the conservation and systematic development of minerals, respectively. Pursuant to these powers, the Mineral Concession Rules, 1960 (MCR, 1960), were enacted, which were later replaced by the Mineral Concession Rules, 2016 (MCR, 2016). Rule 38 of the MCR, 2016, defines ‘Sale Value’ as the gross amount payable as per the sale invoice, excluding taxes. The Explanation to this rule states that no deduction from the gross amount will be made for royalty, payments to the District Mineral Foundation (DMF), and payments to the National Mineral Exploration Trust (NMET). Rule 39(3) of the MCR, 2016, stipulates that royalty is to be paid on an ad valorem basis, calculated as a percentage of the ‘average sale price’ of the mineral. Rule 42 of the MCR, 2016, details how the ‘average sale price’ is computed, using the ‘ex-mine price’ as a base.

The Mineral Conservation and Development Rules, 2017 (MCDR, 2017), also play a role in this case. Rule 45(8)(b) of the MCDR, 2017, defines the ‘ex-mine price’ similarly to the MCR, 2016, and includes an explanation that does not allow deduction of royalty, DMF, and NMET payments when calculating the ‘sale value.’

The core of the dispute lies in the Explanation to Rule 38 of the MCR, 2016, and Rule 45(8)(a) of the MCDR, 2017, which the petitioners argue, leads to a compounding effect on royalty calculations.

Arguments

Submissions of the Petitioners:

• The petitioners, represented by Dr. A.M. Singhvi, argued that the Explanations to Rule 38 of the MCR, 2016, and Rule 45(8)(a) of the MCDR, 2017, which mandate the inclusion of royalty, DMF, and NMET contributions in the computation of ‘sale value,’ lead to a compounding effect. This effectively means that royalty is being charged on previous royalty payments, which is ultra vires to Section 9(3) of the MMDR Act.

• The petitioners contended that this method is manifestly arbitrary because it creates a charge of royalty on the previous month’s royalty. They cited the Supreme Court’s ruling in Mineral Area Development Authority & Anr. v. Steel Authority of India Limited & Anr. [2024 SCC OnLine SC 1974], which stated that royalty is a consideration for extracting minerals and should not be compounded.

• They also pointed out that while Rule 42(2)(b) of the MCR, 2016, excludes other actual expenditures from the sale value, it does not exclude royalty, DMF, and NMET contributions. The petitioners argued that royalty is also an expense and should be excluded.

• The petitioners argued that there is no statutory mandate for including royalty, DMF, and NMET contributions while computing the Average Sale Price (ASP). They emphasized that the impugned explanations are the sole reason for this compounding effect.

• The petitioners highlighted that the Government of India itself acknowledged this anomaly through a committee report by the Ministry of Mines and a public notice dated 25.05.2022. They argued that this acknowledgement is a contemporeo exposito and a valid aid for interpreting the rules, citing K.P. Varghese v. ITO [(1981) 4 SCC 173].

• The petitioners further pointed out that the Ministry of Coal had remedied this anomaly for coal by amending Schedule II of the MMDR Act, which defined “actual price” to exclude royalty, DMF, and NMET contributions. They argued that this differential treatment between coal and other minerals like iron ore is a violation of Article 14 of the Constitution.

• The petitioners also argued that lessees who secured mines through auctions also pay a premium, which is calculated based on the flawed definition of ASP.

Submissions of the Respondents:

• Mr. Shailesh Madiyal, the learned ASG, representing the Union of India, argued that Section 9(1) of the MMDR Act requires royalty payments at rates specified in Schedule II. He also stated that Section 9(3) allows the government to amend Schedule II to adjust royalty rates.

• The respondents submitted that the computation of ASP is done monthly, and the ASP of a particular month is unrelated to the ASP of the previous month, thus negating any cumulative effect on royalty.

• The respondents argued that the term “sale value” is defined in Rule 38 of the MCR, 2016, and its Explanation clarifies that no deductions are allowed for royalty, DMF, and NMET payments.

• The respondents contended that the writ petition filed under Article 32 is not maintainable, and the petitioners should have approached the High Court under Article 226.

• The respondents cited the decision in Natural Resources Allocation, In Re: Special Reference No. 1 of 2012 [(2012) 10 SCC 1], arguing that the methodology for disposing of natural resources is an economic policy matter and should be left to the executive and legislative authorities.

• The respondents argued that the petitioners’ challenge does not meet the threshold of ‘manifest arbitrariness’ and that no evidence was provided to show an endless monthly cumulative exaction of royalty.

• The respondents contended that bidders at the time of auction are aware of the existing legal regime, including Rule 38 of the MCR, 2016, and that changing the calculation method would result in a loss of revenue for the States.

• The respondents further submitted that there is no legal bar on imposing royalty on royalty, as royalty is not a tax, citing Mineral Area Development Authority (supra).

• The respondents acknowledged that the issue is under consideration by a committee, but no decision has been taken yet.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for determination:

1. Whether, the Explanation(s) appended to Rule 38 of the MCR, 2016 and Rule 45 of the MCDR, 2017 respectively are unreasonable and manifestly arbitrary and in consequence of violation of Article 14 of the Constitution?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court analyzed the submissions made by both the petitioners and the respondents, and also considered the authorities cited. The Court acknowledged the petitioners’ argument that the current method of calculating royalty leads to a compounding effect, which effectively means that royalty is being charged on previous royalty payments. However, the Court also noted that the government has the authority to make policy decisions regarding royalty calculations and that courts should not interfere with such decisions unless they are arbitrary or violate the Constitution.

The Court observed that the government itself has acknowledged the anomaly in the compounding of royalty for the purpose of computing average sale price. It also noted that while there is a difference in the mechanism for calculating royalty for coal and other minerals, this difference is not based on any fine distinction between the two.

The Court also noted that the government has initiated a public consultation process for amending the MMDR Act to address the anomaly in the computation of royalty. In light of this, the Court did not definitively rule on the arbitrariness of the Explanations to Rule 38 of the MCR, 2016, and Rule 45 of the MCDR, 2017, but instead directed the respondents to reconsider the mechanism of computation of average sale price and to conclude the public consultation process within a period of two months.

The court clarified that the decision would not preclude the petitioners from challenging the final policy decision that the respondents may take on completion of the ongoing consultation process.

How each authority was viewed by the Court:

✓ Mineral Area Development Authority & Anr. v. Steel Authority of India Limited & Anr. [2024 SCC OnLine SC 1974]: The Court acknowledged the petitioners’ reliance on this case, which stated that royalty is a consideration for extracting minerals and should not be compounded.

✓ K.P. Varghese v. ITO [(1981) 4 SCC 173]: The Court acknowledged the petitioners’ argument that the government’s acknowledgment of the anomaly is a valid aid for interpretation.

✓ Natural Resources Allocation, In Re: Special Reference No. 1 of 2012 [(2012) 10 SCC 1]: The Court acknowledged the respondents’ argument that the manner of computation of royalty is a matter of policy.

✓ M.P. Oil Extraction & Anr. v. State of Madhya Pradesh & Ors, [(1997) 7 SCC 592], Premium Granites & Anr. v. State of Tamil Nadu & Ors. [(1994) 2 SCC 691], Delhi Science Forum and Others v. Union of India and Another [(1996) 2 SCC 405], Balco Employees’ Union v. Union of India [(2002) 2 SCC 333], R.K. Garg v. Union of India [(1981) 4 SCC 675], State of Tamil Nadu and Anr. v. National South Indian River Interlinking Agriculturist Association [(2021) 15 SCC 534]: The Court acknowledged the principle that policy decisions are the domain of the executive and that courts should not interfere unless they are arbitrary or violate the Constitution.

✓ State of Punjab v. Principal Secretary to the Governor of Punjab & Anr. [2023 INSC 1017], State of U.P. v. Achal Singh [(2018) 17 SCC 578]: The Court used these to explain the nature and function of a proviso and an explanation.

✓ Tata Steel Ltd. v. Union of India [(2015) 6 SCC 193]: The Court noted that this case highlighted that coal should not be treated differently from other minerals.

✓ State of Jharkhand v. Brahmputra Metallics Ltd., [(2023) 10 SCC 634], Ramana Dayaram Shetty v. International Airport Authority of India & Ors. [AIR 1979 SC 1628]: The Court used these to emphasize the state’s obligation to act fairly and transparently and to adhere to its stated policies.

✓ Narottam Kishore Deb Varman v. Union of India, [(1964) 7 SCR 55], H.H. Shri Swamiji of Shri Amar Mutt v. Commr., Hindu Religious and Charitable Endowments Deptt., [(1979) 4 SCC 642]: The Court used these to emphasize the need for the government and legislature to act promptly to remove the inequality.

✓ Section 9, 13, 18 of the MMDR Act and Rule 38, 39(3), 42 of the MCR, 2016 and Rule 45(8)(b) of the MCDR, 2017: The Court used these to explain the statutory and regulatory framework governing royalty payments.

Conclusion

The Supreme Court’s judgment in Kirloskar Ferrous Industries Limited & Anr. vs. Union of India & Ors. is significant for the mining industry. While the Court did not definitively rule on the arbitrariness of the current method of calculating royalty, it acknowledged the anomaly in the compounding effect and directed the government to reconsider the mechanism for computing the average sale price. The Court’s decision underscores the need for a fair and transparent method of royalty calculation that does not result in an unfair burden on mining leaseholders.

The Court’s direction to the government to conclude the public consultation process within two months indicates the urgency of the matter. The outcome of this process will have a significant impact on royalty calculations in the mining industry and may lead to amendments in the relevant rules and regulations. The Court has also clarified that the petitioners would not be precluded from challenging the final policy decision that the respondents may take on completion of the ongoing consultation process.

This judgment serves as a reminder that while the government has the authority to make policy decisions, such decisions must be fair, transparent, and consistent with the principles of natural justice and the Constitution. The Supreme Court’s intervention in this matter highlights its role as a guardian of fundamental rights and a protector of the rule of law.

Flowchart of Royalty Calculation Process (Disputed)