Supreme Court Clarifies Sales Tax Exemption for Manufacturing Units: State of Gujarat vs. Arcelor Mittal Nippon Steel India Limited (21 January 2022)

Date of the Judgment: 21 January 2022

Citation: (2022) INSC 62

Judges: M.R. Shah, J. and Sanjiv Khanna, J.

Can a company claim sales tax exemptions on raw materials if it doesn’t directly use them in its manufacturing process, but instead sends them to another company for conversion before using the converted product? The Supreme Court of India recently addressed this question in a case involving a steel manufacturer and the Gujarat state government. This case clarifies the conditions under which businesses can claim tax exemptions on raw materials.

The Supreme Court, in this judgment, addressed whether a steel manufacturing company was eligible for sales tax exemptions on raw materials, specifically naphtha and natural gas, when these materials were transferred to a separate power company for electricity generation, which was then used by the steel company for manufacturing. The court considered the conditions of the exemption notifications issued by the Gujarat government. The judgment was delivered by a two-judge bench comprising Justice M.R. Shah and Justice Sanjiv Khanna, with Justice M.R. Shah authoring the opinion.

Case Background

The case revolves around Arcelor Mittal Nippon Steel India Limited (formerly Essar Steel Ltd.), a company engaged in manufacturing Hot Briquetted Iron (HBI) and Hot Rolled Coil (HRC) at its two units in Hazira, Gujarat. The company was registered under the Gujarat Sales Tax Act, 1969, and the Central Sales Tax Act, 1956. The company’s Unit No. 1 was certified for incentives from 01 August 1990 to 31 July 2004, with an upper monetary limit of Rs. 237.59 crores.

The Government of Gujarat announced a scheme on 26 July 1991, called “The Scheme for Special Incentives to Prestigious Units 1990-95 (modified),” to attract investments in core sector industries. Under this scheme, a prestigious unit was eligible for incentives up to 90% of the fixed capital investment. Essar Steel Ltd. invested approximately Rs. 5000 crores for manufacturing HRC in its Unit No. 2. This unit was granted sales tax exemption from 22 February 1993 to 21 February 2007, up to a maximum monetary limit of Rs. 2050 crores, as per Entry No. 255(2) of a notification dated 05 March 1992, issued under Section 49(2) of the Gujarat Sales Tax Act, 1969.

The exemption granted to Unit No. 2 was for purchase tax on raw materials, specifically naphtha and natural gas. The applicable purchase tax was 16% on naphtha and 20% on natural gas. Notably, this exemption was specifically for steel manufacturing units, excluding electricity generating units. The original Entry No. 255(2) dated 05 March 1992, required that the eligible units actually use the purchased goods within Gujarat as raw materials for manufacturing goods for sale within or outside the state.

Later, this entry was amended on 14 November 2000, stating that the goods should be used by the eligible units as raw materials in their industrial units for which they obtained the eligibility certificate. A further amendment on 16 January 2002, allowed eligible units to claim exemption even if the goods were used to manufacture goods for dispatch to another unit within or outside the state.

Essar Steel Ltd. (ESL) purchased natural gas and naphtha, claiming exemptions, and then sold these to Essar Power Limited (EPL), another company. EPL used these materials to generate electricity, which was then sold back to ESL. ESL used this electricity for manufacturing HRC. The Sales Tax Department raised a dispute, claiming that ESL had breached the conditions of the exemption by transferring the raw materials to EPL.

Initially, the Assessing Officer held that no tax was due from ESL. However, the Deputy Commissioner of Sales Tax later initiated a levy of purchase tax of Rs. 480.99 crores along with a penalty for the period 1995-1996 to 2005-2006. The Joint Commissioner, on appeal, imposed purchase tax for the years 1998-1999 and 1999-2000, but set aside the tax for other years, stating that before the amendment on 14 November 2000, using the purchased goods anywhere in Gujarat was not a breach.

The Gujarat Value Added Tax Tribunal, on further appeal, ruled that ESL was not liable to pay any tax, interest, or penalty. The High Court of Gujarat upheld this decision, citing promissory estoppel and stating that ESL had not violated the original conditions of Entry No. 255(2). The State of Gujarat then appealed to the Supreme Court.

Timeline:

Legal Framework

The case primarily revolves around the interpretation of Entry No. 255(2) of the notifications issued under Section 49(2) of the Gujarat Sales Tax Act, 1969. This section empowers the state government to grant exemptions from sales tax.

The original Entry No. 255(2), dated 05 March 1992, stated that an eligible unit could claim exemption from purchase tax if it furnished a certificate in Form 26, declaring that the purchased goods would be used within the State of Gujarat as raw materials for manufacturing goods for sale, or as packing materials. Condition 6 of this entry specified that the eligible unit must actually use the purchased goods within Gujarat as raw materials.

The notification was amended on 14 November 2000, which modified Entry No. 255(2) to state that the goods should be used in the industrial unit for which the eligibility certificate was obtained. Form 26 was also amended to reflect this change.

A further amendment on 16 January 2002, added condition (1A), stating that the goods could be used in the manufacture of goods for dispatch to another unit within or outside the state. Condition 6(A) was also added, specifying that the eligible unit must use the purchased goods in its industrial unit for the manufacture of goods, which are then dispatched to another unit within or outside the state.

Form 26 was further amended to include the option that the goods would be used in the industrial unit for which the eligibility certificate has been obtained, or for dispatch to another unit within or outside the state.

Arguments

Arguments by the State of Gujarat:

• The State argued that the notification dated 05 March 1992, was the parent notification and subsequent notifications were either clarificatory or expanded the scope of the exemption. These subsequent notifications did not take away any rights conferred by the parent notification.
• The State contended that the original notification extended the exemption only to the ‘eligible unit’ for using raw materials for manufacturing goods in that unit itself. The raw materials, naphtha and natural gas, were required to be used by Essar Steel Ltd. in its own steel unit for manufacturing steel.
• The State argued that if the interpretation by the High Court and the Tribunal was accepted, an eligible unit could simply transfer raw materials to any other unit, even if that unit was not eligible for the exemption. This would defeat the purpose of granting exemptions only to eligible units.
• The State emphasized that power generating companies were specifically listed as ‘ineligible’ for exemptions. Despite this, Essar Steel Ltd. transferred the raw materials to Essar Power Ltd., which used them for generating electricity, thus indirectly benefiting an ineligible entity.
• The State submitted that the exemption notifications should be strictly construed and that any ambiguity should be interpreted in favor of the revenue.
• The State argued that the subsequent notification dated 14 November 2000, was clarificatory and did not modify the basic conditions of availing the exemption. It clarified that the raw materials had to be used in the industrial unit of the eligible unit.
• The State also argued that the High Court erred in applying the principle of promissory estoppel, as the state was empowered to vary or withdraw exemptions.
• The State further argued that even if the subsequent notifications were not applicable, Essar Steel Ltd. still failed to satisfy the conditions of the parent notification, as it did not use the raw materials itself.
• The State contended that every assessment year is independent and that any wrong benefit given in earlier years could be corrected in subsequent years.
• The State argued that given the modus operandi adopted by Essar Steel Ltd. and Essar Power Ltd., the respondent was liable to pay a penalty under Section 45(5) of the Gujarat Sales Tax Act, 1969.

Arguments by Arcelor Mittal Nippon Steel India Limited (formerly Essar Steel Ltd.):

• The respondent argued that it was eligible for exemption under the parent notification dated 05 March 1992, and that the subsequent amendments were not applicable.
• The respondent stated that it had made eligible investments and was entitled to incentives. It had always intended to install a captive power plant but was required by the state to commission a separate power plant through Essar Power Ltd.
• The respondent submitted that the natural gas and naphtha purchased were converted into electricity through Essar Power Ltd. and used as an input for manufacturing HRC. This was done under a job-work arrangement.
• The respondent argued that the original notification only required the goods to be used within the State of Gujarat and did not restrict the use to the eligible unit itself. The transfer to Essar Power Ltd. for conversion to electricity satisfied this condition.
• The respondent contended that a liberal approach should be adopted when determining the scope of incentives, after accepting that an entity is eligible for them.
• The respondent argued that the state had not raised any objections before the second notification and had even confirmed that there was no breach by the respondent.
• The respondent stated that the second notification changed the original condition by requiring use within the industrial unit, which was not permitted as the parent notification only stipulated additional conditions, not amendments to the original condition.
• The respondent argued that the second notification should only apply to industries set up after 14 November 2000.
• The respondent argued that the scheme never envisaged the use of goods in the same form as purchased and that the naphtha and natural gas were used in the form of power in Unit No. 2.
• The respondent contended that any amendment to the original eligibility condition would be prospective and not applicable to units already eligible under the first notification.
• The respondent argued that there was no breach of declarations in Form No. 26, as the goods were ultimately used in the eligible unit.
• The respondent submitted that the demand for purchase tax was barred by the rule of promissory estoppel and legitimate expectation, as it had made significant investments based on the state’s assurances.
• The respondent argued that the imposition of penalty was illegal and without basis, as there was no breach of conditions and no mala fide intention.

Submissions by Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether Essar Steel Ltd. was entitled to the exemption from payment of purchase tax as per the original Entry No. 255(2) vide notification dated 05 March 1992.
2. Whether the subsequent amended Entry No. 255(2) issued vide notifications dated 14 November 2000, and 16 January 2002, altered or amended the basic requirements/conditions stipulated in the first notification dated 05 March 1992.
3. Whether the subsequent amended Entry vide government notifications dated 14 November 2000, and 16 January 2002, took away the right of the respondent to avail the exemption under the first/parent Entry No. 255(2) issued vide notification dated 05 March 1992.
4. Whether there was any breach of the declaration filed by the respondent as per Form No. 26.
5. Whether the demand for purchase tax on and after 14 November 2000, was hit by the principle of promissory estoppel.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

The Supreme Court relied on several authorities to support its reasoning:

• Commissioner of Customs (Import), Mumbai Vs. Dilip Kumar and Company and Others, (2018) 9 SCC 1: The Court cited this case to emphasize that exemption notifications must be construed strictly.
• Union of India and Anr. Etc. Etc. Vs. V.V.F. Limited and Another, Etc. Etc., (2020) SCC Online SC 378: This case was used to support the position that exemption provisions should be strictly construed and that clarificatory amendments apply from the date of the original notification.
• Bengaluru Development Authority Vs. Sudhakar Hegde and Ors., (2020) 15 SCC 63: This case was cited to reinforce the principle that clarificatory amendments apply from the date of the original notification.
• Kothari Industrial Corporation Limited Vs. Tamil Nadu Electricity Board and Anr., (2016) 4 SCC 134: The Court relied on this case to establish that tax exemptions are a concession and do not create any legally enforceable right against the government.
• Assistant Commissioner (CT) LTU and Anr. Vs. Amara Raja Batteries Limited, (2009) 8 SCC 209: While the Court acknowledged the principle of liberal interpretation of incentives, it emphasized that the beneficiary must still fall within the ambit of the exemption and fulfill the conditions.
• Hindustan Steel Ltd. Vs. State of Orissa, (1969) 2 SCC 627 and Excel Crop Care Limited Vs. Competition Commission of India and Anr., (2017) 8 SCC 47: These cases were cited to emphasize that the imposition of penalty is a quasi-criminal adjudication.
• Commissioner of Central Excise, Bangalore – 1 Vs. Bal Pharma Limited, Bangalore and Ors., (2011) 2 SSC 620: This case was cited to support the position that the doctrine of promissory estoppel does not apply in taxing matters.

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the following:

• The explicit language of the original notification, which required the eligible unit to use the raw materials itself.
• The intent of the state government to provide exemptions to specific industries and not to power-generating companies.
• The fact that Essar Steel Ltd. did not use the raw materials itself but transferred them to another entity, which was not eligible for the exemption.
• The need to strictly construe exemption notifications to prevent misuse and ensure that the benefits reach the intended beneficiaries.
• The principle that promissory estoppel does not apply in taxation matters.

Fact:Law Ratio

The court’s decision was influenced by a combination of factual analysis and legal interpretation, with a greater emphasis on the legal aspects of the case.

Logical Reasoning

The Supreme Court considered the explicit language of the original notification, which required the eligible unit to use the raw materials itself. The court also noted that the state government’s intent was to provide exemptions to specific industries and not to power-generating companies. The fact that ESL transferred the raw materials to an ineligible entity was a key factor in the decision. The court emphasized the need to strictly construe exemption notifications to prevent misuse and ensure that benefits reach the intended beneficiaries. The court also held that promissory estoppel does not apply in taxation matters.

The court rejected the argument that the electricity generation was a job-work arrangement, as it found that the raw materials were sold to another entity. The court also rejected the argument that the subsequent notifications were not applicable, as the court found that the subsequent notifications were clarificatory and did not take away any rights under the original notification.

The Supreme Court held that the High Court and the Tribunal had erred in their interpretation of the exemption notification. The Court found that Essar Steel Ltd. had violated the conditions of the original notification by not using the raw materials itself and by transferring them to another entity, which was not eligible for the exemption. The Court also found that the principle of promissory estoppel did not apply in this case.

The Court’s decision was based on a strict interpretation of the exemption notification and a detailed analysis of the facts of the case. The Court’s reasoning was clear and logical, and its decision was supported by relevant authorities.

Conclusion

The Supreme Court overturned the Gujarat High Court’s decision and ruled in favor of the State of Gujarat. The court held that Arcelor Mittal Nippon Steel India Limited (formerly Essar Steel Ltd.) was not entitled to the sales tax exemption on raw materials because the company did not use those materials directly in its manufacturing process. Instead, the materials were transferred to Essar Power Limited for electricity generation, which was then used by Arcelor Mittal Nippon Steel India Limited.

The court emphasized that exemption notifications must be strictly construed and that the benefit of the exemption must be availed by the entity that is intended to receive it. The court also stated that the principle of promissory estoppel does not apply in matters of taxation.

This judgment clarifies that manufacturing units must directly use raw materials to qualify for sales tax exemptions and cannot transfer them to another entity, even if the end product is used in the manufacturing process. This ruling has significant implications for businesses seeking tax exemptions and underscores the importance of adhering strictly to the conditions outlined in exemption notifications.

Implications