Supreme Court Clarifies Deductibility of State Levies Under Section 40(a)(iib) of Income Tax Act: 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, such as license fees and taxes, from its taxable income? The Supreme Court of India addressed this question in a recent case involving the Kerala State Beverages Manufacturing & Marketing Corporation Ltd. (KSBC). The core issue was whether certain payments made by KSBC to the Kerala State Government, including gallonage fees, license fees, shop rentals, surcharge on sales tax, and turnover tax, could be disallowed as deductions under Section 40(a)(iib) of the Income-tax Act, 1961. The Supreme Court, in this judgment, clarified the scope of this provision, providing much-needed guidance on the deductibility of such payments. The judgment was delivered by a bench comprising Justice R. Subhash Reddy and Justice Hrishikesh Roy.

Case Background

The Kerala State Beverages Manufacturing & Marketing Corporation Ltd. (KSBC), a state-owned company engaged in the wholesale and retail trade of beverages, was assessed for the assessment years 2014-2015 and 2015-2016. For the assessment year 2014-2015, the Deputy Commissioner of Income Tax finalized the assessment under Section 143(3) of the Income-tax Act, 1961, on December 14, 2016. Subsequently, the Principal Commissioner of Income Tax, Thiruvananthapuram, revised this order under Section 263 of the Act on September 25, 2018, disallowing the debit entries in the Profit & Loss Account related to surcharge on sales tax and turnover tax, citing Section 40(a)(iib) of the Income-tax Act, 1961.

For the assessment year 2015-2016, the Assistant Commissioner of Income Tax disallowed debits in the Profit & Loss Account amounting to Rs. 811,90,88,115, which included gallonage fees, license fees, shop rentals (kist), and surcharge on sales tax, under Section 40(a)(iib) of the Income-tax Act, 1961. This order was dated December 28, 2017.

Appeals were filed by KSBC before the Income Tax Appellate Tribunal (Tribunal) against these disallowances. The Tribunal initially dismissed the appeals on March 12, 2019, but later recalled the order for the assessment year 2015-2016 to consider the issue of surcharge on sales tax. The Tribunal then passed a fresh order on October 11, 2019, dismissing the appeal.

Aggrieved by these orders, KSBC filed appeals before the High Court of Kerala, which were disposed of by a common order. The High Court partly ruled in favor of the assessee and partly in favor of the revenue. It held that gallonage fees, license fees, and shop rentals for FL-9 licenses were disallowable under Section 40(a)(iib), while those for FL-1 licenses were not. The High Court also held that the surcharge on sales tax and turnover tax were not ‘fees’ or ‘charges’ under Section 40(a)(iib) and hence, were allowable.

Timeline:

Course of Proceedings

The Principal Commissioner of Income Tax, Thiruvananthapuram, exercised revisionary powers under Section 263 of the Income-tax Act, 1961, setting aside the assessment order for 2014-2015. The reason was that the assessing officer failed to disallow debits related to surcharge on sales tax and turnover tax, which should have been disallowed under Section 40(a)(iib) of the Income-tax Act, 1961.

The Income Tax Appellate Tribunal (Tribunal) initially dismissed the appeals for both assessment years 2014-2015 and 2015-2016. However, the Tribunal recalled its order for the assessment year 2015-2016 to reconsider the disallowance of surcharge on sales tax. After a fresh hearing, the Tribunal again dismissed the appeal.

The High Court of Kerala, in its common order, partly allowed the appeals. It held that gallonage fees, license fees, and shop rentals related to FL-9 licenses were disallowable under Section 40(a)(iib) of the Income-tax Act, 1961, as these were exclusive levies on the appellant. However, it ruled that similar payments related to FL-1 licenses were not disallowable because such licenses were also issued to another state-owned entity. The High Court also held that surcharge on sales tax and turnover tax were not ‘fees’ or ‘charges’ under Section 40(a)(iib) and hence, were allowable.

Legal Framework

Section 40 of the Income-tax Act, 1961, specifies amounts that are 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, which disallows certain payments made by State Government undertakings.

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

“40. Amounts not deductible. – Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”,-

(a) in the case of any assessee-

(i) … … … …

(iib) any amount –

(A) 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; or

(B) which is appropriated, directly or indirectly, from, a State Government undertaking by the State Government.

Explanation.-For the purposes of this sub-clause, a State Government undertaking includes –

(i) a corporation established by or under any Act of the State Government;

(ii) a company in which more than fifty per cent of the paid-up equity share capital is held by the State Government;

(iii) a company in which more than fifty per cent of the paid-up equity share capital is held by the entity referred to in clause (i) or clause (ii) (whether singly or taken together);

(iv) a company or corporation in which the State Government has the right to appoint the majority of the directors or to control the management or policy decisions, directly or indirectly, including by virtue of its shareholding or management rights or shareholders agreements or voting agreements or in any other manner;

(v) an authority, a board or an institution or a body established or constituted by or under any Act of the State Government or owned or controlled by the State Government;”.

The provision aims to prevent State Governments from shifting profits from their undertakings into the state treasury by way of fees, charges, or other similar appropriations, thus avoiding taxes.

Article 289 of the Constitution of India exempts the property and income of a State from Union taxation. This constitutional protection has led states to shift income/profits from State Government Undertakings into the Consolidated Fund of the States.

Arguments

Appellant (KSBC) Arguments:

• The gallonage fees, license fees, and shop rentals for both FL-9 and FL-1 licenses, as well as the surcharge on sales tax and turnover tax, do not fall under Section 40(a)(iib) of the Income-tax Act, 1961.
• The levies are on the licensee, not exclusively on the State Government Undertaking. The licenses are granted based on the State’s Abkari Policy, which can vary yearly.
• The surcharge on sales tax is an increment to the basic sales tax under Section 5(1) of the Kerala General Sales Tax Act, 1963, and is not a ‘fee’ or ‘charge’ as contemplated under Section 40(a)(iib) of the Income-tax Act, 1961.
• The assessing officer’s initial decision to allow deductions for surcharge on sales tax and turnover tax for the assessment year 2014-2015 was a possible view, and therefore, the revisional power under Section 263 of the Income-tax Act, 1961, should not have been invoked.
• Relied on C.I.T. v. K. Srinivasan [1972(4) SCC 526] and Sarojini Tea Co. Ltd. v. Collector, Dibrugarh [(1992) 2 SCC 156] to argue that a surcharge is an enhancement of tax.
• Cited CBDT Circular No. 3/2018 dated 11.07.2018, to support that sales tax and turnover tax are outside the scope of Section 40(a)(iib) of the Income-tax Act, 1961.

Respondent (Revenue) Arguments:

• The amendment to Section 40 of the Income-tax Act, 1961, by Act 17 of 2013, was intended to prevent States from shifting profits from State Government Undertakings to the Consolidated Fund of the States, thus avoiding taxes.
• The gallonage fees, license fees, and shop rentals are exclusive levies on KSBC, especially for FL-9 licenses, and should be disallowed under Section 40(a)(iib) of the Income-tax Act, 1961.
• The disallowance under Section 40(a)(iib) of the Income-tax Act, 1961, is not contingent on the nature of the license but on whether the levy is exclusive to a State Government Undertaking.
• Even if the surcharge on sales tax is not covered under Section 40(a)(iib)(A), it should be considered as an appropriation under Section 40(a)(iib)(B), as it is a tax and a form of appropriation by the State.
• Relied on Jalkal Vibhag Nagar Nigam & Ors. v Pradeshiya Industrial and Investment Corporation and Another [2021 SCC OnLine SC 960] to argue that the distinction between ‘tax’ and ‘fee’ has been substantially effaced.
• Turnover tax is also an exclusive levy on KSBC, and thus, it should be disallowed under Section 40(a)(iib) of the Income-tax Act, 1961.

Issues Framed by the Supreme Court

The Supreme Court addressed the following issues:

1. Whether gallonage fees, license fees, and shop rental (kist) with respect to FL-9 and FL-1 licenses granted to the appellant fall within the purview of Section 40(a)(iib) of the Income-tax Act, 1961?
2. Whether the surcharge on sales tax and turnover tax is a ‘fee’ or ‘charge’ coming within the scope of Section 40(a)(iib) of the Income-tax Act, 1961?

The Court also considered, as a sub-issue, whether the interpretation of the term ‘exclusively’ under Section 40(a)(iib) should be based on the nature of the undertaking or the number of undertakings on which the levy is imposed.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each authority was viewed by the Court:

• C.I.T. v. K. Srinivasan [1972(4) SCC 526]: The Supreme Court followed this case, reiterating that a surcharge is an enhancement of the tax.
• Sarojini Tea Co. Ltd. v. Collector, Dibrugarh [(1992) 2 SCC 156]: The Supreme Court followed this case, stating that a surcharge on a tax is part of the tax.
• Jalkal Vibhag Nagar Nigam & Ors. v Pradeshiya Industrial and Investment Corporation and Another [2021 SCC OnLine SC 960]: The Supreme Court distinguished this case, stating that it does not negate the distinction between ‘fee’ and ‘tax’.
• DLF Qutab Enclave Complex Educational Charitable Trust v. State of Haryana & Ors. [(2003) 5 SCC 622], Kailash Nath Agarwal & Ors. v. Pradeshiya Industrial & Investment Corporation of U.P. Ltd. & Anr. [(2003) 4 SCC 305], and Shri Ishar Alloy Steels Ltd. v. Jayaswals Neco Ltd. [(2001) 3 SCC 609]: The Supreme Court followed these cases to interpret that when the same statute uses different terms, it refers to distinct and different things.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the intent behind the amendment to Section 40 of the Income-tax Act, 1961, which was to prevent the shifting of profits from State Government Undertakings to the State treasury to avoid taxes. The Court emphasized that the term “exclusively” in Section 40(a)(iib) should be interpreted based on the nature of the undertaking and not on the number of undertakings on which the levy is imposed. The court also focused on the distinction between ‘tax’ and ‘fee’ as maintained in the Income-tax Act, 1961.

The court’s reasoning was more heavily influenced by legal interpretation and the intent of the law than by the specific facts of the case.

Logical Reasoning:

The Court rejected the argument that the term ‘exclusively’ should be interpreted narrowly, based on the number of State-owned undertakings, as such an interpretation would defeat the intent of the legislation. The Court also emphasized the distinction between ‘tax’ and ‘fee’ as maintained in the Income-tax Act, 1961, noting that where Parliament intended to include tax, it specifically mentioned it as such.

The court stated that the interpretation of the term ‘exclusively’ under Section 40(a)(iib) should be based on the nature of the undertaking and not on the number of undertakings on which the levy is imposed. The Court held that both KSBC and the Kerala State Co-operatives Consumers’ Federation Ltd. are undertakings of the State of Kerala, and hence, any levy imposed on them is an exclusive levy on State Government Undertakings.

The Court also held that the surcharge on sales tax and turnover tax are taxes and not ‘fees’ or ‘charges’ as contemplated under Section 40(a)(iib) of the Income-tax Act, 1961. The court noted that the Income-tax Act, 1961, carefully maintains a distinction between ‘tax’ and ‘fee,’ and if these words were to include tax or surcharge, it would obliterate the distinction.

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 Court also observed that: “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.”

Further, the court noted that: “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.”

There were no dissenting opinions in this case.

Key Takeaways

• Gallonage fees, license fees, and shop rentals paid by State Government Undertakings are not deductible under Section 40(a)(iib) of the Income-tax Act, 1961, regardless of the number of State-owned entities holding similar licenses.
• Surcharge on sales tax and turnover tax are not considered ‘fees’ or ‘charges’ under Section 40(a)(iib) and are therefore deductible.
• The term ‘exclusively’ in Section 40(a)(iib) refers to the nature of the undertaking and not the number of undertakings on which the levy is imposed.
• The Income-tax Act, 1961, maintains a clear distinction between ‘tax’ and ‘fee,’ and this distinction should be respected in interpreting Section 40(a)(iib).

Directions

The Supreme Court set aside the assessments completed against the assessee for the assessment years 2014-2015 and 2015-2016. The assessing officer was directed to pass revised orders, computing the liability in accordance with the directions given by the Supreme Court, within two months from the date of receipt of the judgment.

Development of Law

The ratio decidendi of this case is that the term ‘exclusively’ in Section 40(a)(iib) of the Income-tax Act, 1961, should be interpreted based on the nature of the undertaking and not on the number of undertakings on which the levy is imposed. Additionally, the Court clarified that the term ‘fee’ or ‘charge’ does not include ‘tax’ or ‘surcharge on tax’. This decision clarifies the scope of Section 40(a)(iib) and provides guidance on the deductibility of payments made by State Government Undertakings to the State. This decision also reaffirms the distinction between ‘tax’ and ‘fee’ as maintained in the Income-tax Act, 1961.

Conclusion

The Supreme Court’s judgment in the case of Kerala State Beverages vs. ACIT (2022) provides significant clarification on the interpretation of Section 40(a)(iib) of the Income-tax Act, 1961. The Court’s ruling that the term ‘exclusively’ refers to the nature of the undertaking, rather than the number of undertakings, ensures that the legislative intent of preventing tax avoidance by State Governments is upheld. Furthermore, the clarification that surcharge on sales tax and turnover tax are not ‘fees’ or ‘charges’ provides much-needed certainty for State Government Undertakings. This judgment serves as an important precedent for future cases involving similar issues, emphasizing the importance of adhering to the legislative intent and maintaining a clear distinction between different types of levies.