Supreme Court Clarifies Deductibility of Fees and Taxes for State-Owned Liquor Corporation: Kerala State Beverages vs. ACIT (2022)

Date of the Judgment: January 03, 2022
Citation: (2022) INSC 1
Judges: R. Subhash Reddy, J., Hrishikesh Roy, J.

Can a state-owned corporation deduct payments made to the state government as business expenses? The Supreme Court of India recently tackled this complex issue, focusing on the interpretation of Section 40(a)(iib) of the Income-tax Act, 1961. This case revolves around the Kerala State Beverages Manufacturing & Marketing Corporation Ltd. (KSBC) and its claim for deductions on various fees and taxes paid to the Kerala State Government.

The core question was whether gallonage fees, license fees, shop rentals, surcharge on sales tax, and turnover tax paid by KSBC should be considered deductible expenses or not. The Supreme Court examined the legislative intent behind Section 40(a)(iib) and its implications for state-owned undertakings. The bench comprised Justices R. Subhash Reddy and Hrishikesh Roy, with the majority opinion authored by Justice R. Subhash Reddy.

Case Background

The Kerala State Beverages Manufacturing & Marketing Corporation Ltd. (KSBC), a state-owned company, is engaged in the wholesale and retail trade of beverages. For the assessment year 2014-2015, the Deputy Commissioner of Income Tax finalized the assessment of KSBC’s income under Section 143(3) of the Income-tax Act, 1961. However, the Principal Commissioner of Income Tax, Thiruvananthapuram, revised this assessment under Section 263 of the Act, disallowing certain debits made by KSBC in its Profit & Loss Account. These debits pertained to the surcharge on sales tax and turnover tax paid to the State Government, which the Principal Commissioner argued should have been disallowed under Section 40(a)(iib) of the Act.

Similarly, for the assessment year 2015-2016, the Assistant Commissioner of Income Tax disallowed debits in KSBC’s Profit & Loss Account related to payments of gallonage fee, license fee, shop rental (kist), and surcharge on sales tax, totaling ₹811,90,88,115, under Section 40(a)(iib) of the Act. KSBC appealed these disallowances, leading to a series of proceedings.

Timeline:

Course of Proceedings

The Principal Commissioner of Income Tax, Thiruvananthapuram, revised the assessment for 2014-2015, disallowing the debits for surcharge on sales tax and turnover tax. KSBC appealed this revision to the Income Tax Appellate Tribunal (Tribunal), which dismissed the appeal. For the assessment year 2015-2016, the Commissioner of Income Tax (Appeals) also dismissed KSBC’s appeal against the disallowance of gallonage fee, license fee, shop rental, and surcharge on sales tax. The Tribunal initially dismissed both appeals in a common order but later recalled the order for 2015-2016 to reconsider the surcharge on sales tax issue, ultimately ruling against KSBC again.

Aggrieved by these orders, KSBC filed Income Tax Appeals before the High Court of Kerala. The High Court partly ruled in favor of the assessee and partly in favor of the revenue. The High Court held that gallonage fee, license fee, and shop rental for FL-9 licenses were disallowable under Section 40(a)(iib), but the same fees for FL-1 licenses were not. The High Court also ruled that the surcharge on sales tax and turnover tax were not a ‘fee or charge’ under Section 40(a)(iib). Both KSBC and the revenue appealed to the Supreme Court against this order.

Legal Framework

The case primarily revolves around Section 40 of the Income-tax Act, 1961, which specifies amounts not deductible when computing income under the head “Profits and gains of business or profession.” The Finance Act, 2013, introduced Section 40(a)(iib), effective from April 1, 2014. This section disallows deductions for:

• (A) Any amount paid by way of royalty, license fee, service fee, privilege fee, service charge, or any other fee or charge, by whatever name called, which is levied exclusively on a State Government undertaking.
• (B) Any amount which is appropriated, directly or indirectly, from a State Government undertaking by the State Government.

The explanation to this sub-clause defines a State Government undertaking to include corporations, companies with majority state ownership, and other entities controlled by the State Government.

The core issue is to determine whether the fees and taxes paid by KSBC fall under the ambit of Section 40(a)(iib) and are thus not deductible. The provision was introduced to prevent state governments from shifting profits from their undertakings into the state treasury by levying fees and charges, thereby avoiding taxes.

Arguments

Appellant (KSBC) Arguments:

• The gallonage fees, license fee, and shop rental (kist) for FL-9 licenses are not levied exclusively on a State Government Undertaking but on the licensee. The levy is on the license holder, regardless of who it is.

• The decision to grant FL-9 licenses to KSBC depends on the State Government’s Abkari Policy, which varies yearly. Therefore, it’s not an exclusive levy on KSBC.

• The same argument applies to gallonage fees, license fees, and shop rental for FL-1 licenses, an issue already decided in favor of the appellant by the High Court.

• The surcharge on sales tax and turnover tax are taxes, not fees or charges, and fall outside the scope of Section 40(a)(iib) of the Act.

• The Kerala Surcharge on Taxes Act, 1957, is only to increase taxes on the sale or purchase of goods, making it an increment to the basic sales tax.

• The assessing officer’s initial view to allow deductions for surcharge on sales tax and turnover tax was a possible view, and the Commissioner’s revision was not permissible.

Respondent (Revenue) Arguments:

• The amendment to Section 40 of the Income-tax Act, 1961, was intended to prevent states from shifting profits from State Government Undertakings into the Consolidated Fund of the States.

• State Government Undertakings are treated as commercial entities and should not be allowed to shift profits by appropriating them as fees, taxes, or similar appropriations.

• The levy of gallonage fees, license fees, and shop rental is an exclusive levy on KSBC, as it is the sole FL-9 license holder.

• The disallowance under Section 40(a)(iib) is not contingent on the nature of the license but on whether the levy is exclusive.

• The aspect of exclusivity should be viewed from the nature of the undertaking on which the levy is imposed, not on the number of undertakings.

• The surcharge on sales tax is an exclusive levy on KSBC, attracting Section 40(a)(iib)(A). Alternatively, it falls under Section 40(a)(iib)(B) as a form of appropriation by the State from KSBC.

• The surcharge is levied on the tax payable by a dealer in foreign liquor, specifically KSBC, under Section 5(1) of the KGST Act.

• Turnover tax is not an exclusive levy on KSBC, and the issue should be left open for fresh adjudication.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court considered the following issues:

1. Whether the gallonage fee, license fee, and shop rental (kist) with respect to FL-9 and FL-1 licenses are covered under Section 40(a)(iib) of the Income-tax Act, 1961?
2. Whether the surcharge on sales tax and turnover tax fall within the ambit of Section 40(a)(iib) of the Income-tax Act, 1961?

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:

Cases:

• C.I.T. v. K. Srinivasan [1972(4) SCC 526] – Supreme Court of India

  The Court referred to this case to support the view that a surcharge on a tax is nothing but an enhancement of the tax itself.

• Sarojini Tea Co. Ltd. v. Collector, Dibrugarh [(1992) 2 SCC 156] – Supreme Court of India

  The Court cited this case to further support that a surcharge on a tax is an enhancement of the tax.

• Jalkal Vibhag Nagar Nigam & Ors. v Pradeshiya Industrial and Investment Corporation and Another [2021 SCC OnLine SC 960] – Supreme Court of India

  The Court noted that this case maintains the basic constitutional distinction between ‘fee’ and ‘tax’, and does not support the revenue’s case.

• DLF Qutab Enclave Complex Educational Charitable Trust v. State of Haryana & Ors. [(2003) 5 SCC 622] – Supreme Court of India

  The Court referred to this case to emphasize that where the same statute uses different terms and expressions, the legislature is referring to distinct and different things.

• Kailash Nath Agarwal & Ors. v. Pradeshiya Industrial & Investment Corporation of U.P. Ltd. & Anr. [(2003) 4 SCC 305] – Supreme Court of India

  The Court cited this case to further emphasize that where the same statute uses different terms and expressions, the legislature is referring to distinct and different things.

• Shri Ishar Alloy Steels Ltd. v. Jayaswals Neco Ltd. [(2001) 3 SCC 609] – Supreme Court of India

  The Court referred to this case to further emphasize that where the same statute uses different terms and expressions, the legislature is referring to distinct and different things.

Legal Provisions:

• Section 40 of the Income-tax Act, 1961

  This section deals with amounts not deductible while computing income under the head ‘Profits and gains of business or profession’.

• Section 40(a)(iib) of the Income-tax Act, 1961

  This provision, inserted by the Finance Act, 2013, disallows deductions for certain fees and charges levied exclusively on State Government undertakings.

• Section 143(3) of the Income-tax Act, 1961

  This section deals with assessment of income.

• Section 263 of the Income-tax Act, 1961

  This section deals with power of revision by the Principal Commissioner.

• Section 18A of the Kerala Abkari Act

  This section deals with gallonage fee.

• Rule 15A of the Foreign Liquor Rules.

  This rule deals with gallonage fee.

• Section 3(1) of the Kerala Surcharge on Taxes Act, 1957

  This section deals with the levy of surcharge on sales and purchase taxes.

• Section 5(1) of the Kerala General Sales Tax Act, 1963

  This section deals with the levy of tax on sale or purchase of goods.

• Article 289 of the Constitution of India

  This article deals with exemption of property and income of a State from Union taxation.

Judgment

How each authority was viewed by the Court?

• C.I.T. v. K. Srinivasan [1972(4) SCC 526]: The Court used this case to support the view that a surcharge on a tax is an enhancement of the tax.
• Sarojini Tea Co. Ltd. v. Collector, Dibrugarh [(1992) 2 SCC 156]: The Court relied on this case to further support that a surcharge on a tax is an enhancement of the tax.
• Jalkal Vibhag Nagar Nigam & Ors. v Pradeshiya Industrial and Investment Corporation and Another [2021 SCC OnLine SC 960]: The Court held that this judgment maintains the distinction between ‘fee’ and ‘tax’ and does not support the revenue’s case.
• DLF Qutab Enclave Complex Educational Charitable Trust v. State of Haryana & Ors. [(2003) 5 SCC 622]: The Court used this case to emphasize that different terms in the same statute refer to distinct things.
• Kailash Nath Agarwal & Ors. v. Pradeshiya Industrial & Investment Corporation of U.P. Ltd. & Anr. [(2003) 4 SCC 305]: The Court cited this case to further emphasize that different terms in the same statute refer to distinct things.
• Shri Ishar Alloy Steels Ltd. v. Jayaswals Neco Ltd. [(2001) 3 SCC 609]: The Court referred to this case to further emphasize that different terms in the same statute refer to distinct things.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the legislative intent behind Section 40(a)(iib) of the Income-tax Act, 1961. The Court aimed to prevent the shifting of profits from State Government Undertakings to the State treasury, thereby avoiding taxes. The Court also emphasized the distinction between ‘fees’ and ‘taxes’ as maintained in the Income-tax Act.

Fact:Law Ratio

The Court’s reasoning was heavily based on legal interpretation and the legislative intent behind Section 40(a)(iib), with a lesser emphasis on the factual aspects of the case.

Logical Reasoning:

The Court rejected the interpretation that the term “exclusively” in Section 40(a)(iib) should be narrowly construed to mean that the levy must be on a single undertaking. The Court emphasized that the legislative intent was to prevent profit shifting, and this would be defeated if state governments could simply create multiple state-owned undertakings to avoid the provision.

The Court also considered the alternative argument that the surcharge on sales tax could be considered an appropriation under Section 40(a)(iib)(B). However, the Court rejected this argument, noting that the Income-tax Act maintains a clear distinction between ‘fees’ and ‘taxes’, and the term ‘appropriation’ cannot be interpreted to include taxes.

The Court’s decision was based on a careful reading of the legal provisions, the legislative intent, and the precedents. The Court also considered the arguments of both parties, but ultimately, it ruled in favor of the revenue on the issue of gallonage fees, license fees, and shop rentals, and in favor of the assessee on the issue of surcharge on sales tax and turnover tax.

The Supreme Court held that:

• The gallonage fee, license fee, and shop rental (kist) with respect to FL-9 and FL-1 licenses granted to the appellant will, squarely fall within the purview of Section 40(a)(iib) of the Income-tax Act, 1961.
• The surcharge on sales tax and turnover tax are not a fee or charge coming within the scope of Section 40(a)(iib)(A) or 40(a)(iib)(B), and thus, cannot be disallowed under the said provision.

The court quoted from the judgment:

“The aspect of ‘exclusivity’ under Section 40(a)(iib) has to be viewed from the nature of undertaking on which levy is imposed and not on the number of undertakings on which the levy is imposed.”

“The ‘fee’ or ‘charge’ as mentioned in Section 40(a)(iib) is clear in terms and that will take in only ‘fee’ or ‘charge’ as mentioned therein or any fee or charge by whatever name called, but cannot cover tax or surcharge on tax and such taxes are outside the scope and ambit of Section 40(a)(iib)(A) and Section 40(a)(iib)(B) of the Act.”

“If these words are considered to include a tax or surcharge like sales tax, the distinction so carefully spelt out in Section 40 between a tax and a fee will be obliterated and rendered meaningless.”

Key Takeaways

• State-owned undertakings cannot claim deductions for fees and charges that are exclusively levied on them by the State Government.
• The term “exclusively” in Section 40(a)(iib) refers to the nature of the undertaking and not the number of undertakings.
• Surcharges on taxes are considered taxes themselves and are not covered under Section 40(a)(iib).
• The distinction between ‘fees’ and ‘taxes’ is maintained under the Income-tax Act, 1961.
• This judgment clarifies the scope of Section 40(a)(iib) and its applicability to State Government Undertakings.

The decision may lead to further scrutiny of deductions claimed by State Government Undertakings and could impact the financial planning of these entities. The judgment also highlights the importance of legislative intent in interpreting tax laws and the need for a clear distinction between fees and taxes. In future cases, the courts will likely follow the Supreme Court’s interpretation of ‘exclusivity’ and the distinction between ‘fees’ and ‘taxes’.