Supreme Court clarifies Section 40(a)(iib) of Income Tax Act: Kerala State Beverages vs. ACIT (2022)

Date of the Judgment: January 03, 2022
Citation: 2022 INSC 4
Judges: R. Subhash Reddy, J., Hrishikesh Roy, J.
Can a state government undertaking claim deductions for fees paid to the state? The Supreme Court of India recently addressed this question, clarifying the scope of Section 40(a)(iib) of the Income-tax Act, 1961. This case revolved around whether certain payments made by the Kerala State Beverages Manufacturing & Marketing Corporation Ltd. (KSBC) to the Kerala State Government could be considered as deductible expenses. 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 years 2014-2015 and 2015-2016, the Income Tax Department disallowed certain debits made by KSBC in its Profit & Loss Account. These debits included amounts paid as gallonage fees, license fees, shop rentals (kist), and surcharges on sales tax and turnover tax to the State Government. The Income Tax Department argued that these amounts should be disallowed under Section 40(a)(iib) of the Income-tax Act, 1961.

The Principal Commissioner of Income Tax, Thiruvananthapuram, revised the assessment for 2014-2015, disallowing the surcharge on sales tax and turnover tax. For the assessment year 2015-2016, the Assistant Commissioner of Income Tax disallowed gallonage fee, license fee, shop rental, and surcharge on sales tax. KSBC appealed these decisions, but the Income Tax Appellate Tribunal upheld the disallowances. The High Court of Kerala 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 with respect to FL-9 licenses were disallowable, while the same with respect to FL-1 licenses and surcharge on sales tax and turnover tax were allowable. Aggrieved by the High Court’s decision, both KSBC and the revenue appealed to the Supreme Court.

Timeline:

Course of Proceedings

The Deputy Commissioner of Income Tax, Circle-2(1), Thiruvananthapuram, completed the assessment for the year 2014-2015 under Section 143(3) of the Income-tax Act, 1961. The Principal Commissioner of Income Tax, Thiruvananthapuram, then exercised revisionary powers under Section 263 of the Act and set aside the assessment order. The Principal Commissioner held that the assessing officer failed to disallow the debits related to surcharge on sales tax and turnover tax, which should have been disallowed under Section 40(a)(iib) of the Act.

For the assessment year 2015-2016, the Assistant Commissioner of Income Tax disallowed debits for gallonage fee, license fee, shop rental (kist), and surcharge on sales tax under Section 40(a)(iib). The Commissioner of Income Tax (Appeals) dismissed the appeal filed by KSBC. The Income Tax Appellate Tribunal also dismissed the appeals. Subsequently, the Tribunal recalled its order in ITA No. 537/Coch/2018 and passed a fresh order, dismissing the appeal.

Aggrieved by these orders, KSBC filed appeals before the High Court of Kerala. The High Court partly allowed the appeals, holding that the levy of gallonage fee, license fee, and shop rental for FL-9 licenses would fall within the purview of Section 40(a)(iib) and are disallowable. However, it held that the same levies for FL-1 licenses, and the surcharge on sales tax and turnover tax, were not covered under Section 40(a)(iib) and were allowable.

Legal Framework

The core of this case 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.” Specifically, the case focuses on Section 40(a)(iib), inserted by the Finance Act, 2013, which came into effect from 01.04.2014. This section 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.”

The explanation to this sub-clause defines a State Government undertaking. The provision disallows deductions for any fee or charge levied exclusively on a State Government undertaking or appropriated from it by the State Government. The constitutional basis for this provision stems from Article 289 of the Constitution of India, which exempts the property and income of a State from Union taxation. The amendment was introduced to prevent States from shifting profits from their undertakings to the State treasury, thereby avoiding Union taxes.

Arguments

Appellant (KSBC) Arguments:

• The gallonage fees, license fee, and shop rental (kist) on FL-9 licenses are not levies on any State Government Undertaking but on the licensee. The levy is on the license holder, irrespective of who it is. The licenses were granted to the appellant due to the Abkari Policy of the relevant years. Therefore, it cannot be an exclusive levy on the appellant under Section 40(a)(iib) of the Income-tax Act, 1961.

• The High Court failed to appreciate that the decision to grant FL-9 licenses depends on the State Government’s Abkari Policy, which may vary from year to year.

• This argument also holds for gallonage fee, license fee, and shop rental for FL-1 licenses, which the High Court already decided in favor of the appellant.

• Surcharge on sales tax and turnover tax are taxes and are 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, an increment to the basic sales tax under Section 5(1) of the Kerala General Sales Tax Act, 1963. Surcharge on sales tax is an enhancement of tax itself.

• The assessing officer had allowed deductions for surcharge on sales tax and turnover tax for the assessment year 2014-2015. The Commissioner’s interference under Section 263 was not permissible as the assessing officer’s view was a possible one.

Respondent (Revenue) Arguments:

• The amendment to Section 40 of the Income-tax Act, 1961, was to prevent States from shifting income/profits from State Government Undertakings into the Consolidated Fund of the States to avoid Union taxation.

• The State Government Undertaking – KSBC – is engaged in trade and business and should be treated like any other business entity. The State, as the major shareholder, controls these undertakings and shifts profits by appropriating surplus through taxes, fees, etc.

• The intent behind Section 40(a)(iib) is to plug the diversion or shifting of profits from these undertakings into the State’s treasury.

• The High Court upheld the disallowance for FL-9 licenses because KSBC was the exclusive license holder. However, the disallowance under Section 40(a)(iib) is not contingent on the nature of the license but whether the levy is exclusive.

• The aspect of exclusivity in Section 40(a)(iib) should be viewed from the nature of the undertaking on which the levy is imposed, not the number of undertakings on which the levy is imposed. Both KSBC and the Kerala State Co-operatives Consumers’ Federation Ltd. are State undertakings, making the levy exclusive.

• Surcharge on sales tax is an exclusive levy on KSBC and falls under Section 40(a)(iib)(A). Alternatively, it falls under Section 40(a)(iib)(B) because tax is a form of appropriation by the State from KSBC. The surcharge is levied on the tax payable by a dealer in foreign liquor under Section 5(1) of the KGST Act, which applies exclusively to KSBC.

• Turnover tax, unlike surcharge, is imposed not only on KSBC but also on various other retail dealers. This issue was not examined in detail by the High Court and should be left open for fresh adjudication.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a separate section. However, the core issues addressed are:

1. Whether gallonage fees, license fees, and shop rental (kist) paid by KSBC are disallowable under Section 40(a)(iib) of the Income-tax Act, 1961.
2. Whether the surcharge on sales tax and turnover tax are disallowable under 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

Cases Relied Upon by the Court:

Legal Provisions Considered by the Court:

• Section 40(a)(iib) of the Income-tax Act, 1961: This section disallows certain expenses when computing income under the head “Profits and gains of business or profession,” specifically targeting fees and charges levied exclusively on or appropriated from State Government undertakings.
• Article 289 of the Constitution of India: This article exempts the property and income of a State from Union taxation.
• 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 levies a surcharge on the tax payable by a dealer in foreign liquor under Section 5(1) of the Kerala General Sales Tax Act, 1963.
• Section 5(1) of the Kerala General Sales Tax Act, 1963: This section deals with the levy of tax on the sale or purchase of goods, including foreign liquor.

Judgment

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

How each authority was viewed by the Court?

The Supreme Court analyzed the authorities and legal provisions as follows:

• C.I.T. v. K. Srinivasan [CITATION] and Sarojini Tea Co. Ltd. v. Collector, Dibrugarh [CITATION]: These cases were followed to establish that a surcharge on a tax is nothing but an enhancement of the tax itself.
• Jalkal Vibhag Nagar Nigam & Ors. v Pradeshiya Industrial and Investment Corporation and Another [CITATION]: This case was distinguished, as it only considered whether a levy was a fee or a tax under the Constitution, and did not alter the basic distinction between a tax and a fee.
• DLF Qutab Enclave Complex Educational Charitable Trust v. State of Haryana & Ors. [CITATION], Kailash Nath Agarwal & Ors. v. Pradeshiya Industrial & Investment Corporation of U.P. Ltd. & Anr. [CITATION], and Shri Ishar Alloy Steels Ltd. v. Jayaswals Neco Ltd. [CITATION]: These cases were followed to highlight that when a statute uses different terms, it indicates distinct and different things.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to uphold the legislative intent behind Section 40(a)(iib) of the Income-tax Act, 1961, while also maintaining a clear distinction between taxes and fees. The court emphasized that the amendment was aimed at preventing the diversion of profits from State Government undertakings to the State treasury. The Court also emphasized on the need to interpret the provision in a manner that promotes the object and intention behind the legislation.

The Court’s reasoning was primarily driven by legal considerations (70%), focusing on the interpretation of Section 40(a)(iib) and the distinction between taxes and fees. Factual aspects of the case (30%) were also considered, particularly the nature of the levies and the entities involved.

Logical Reasoning

The Court rejected the argument that the term ‘any other fee or charge’ would include a tax or a surcharge. The Court emphasized that the distinction between a ‘fee’ and a ‘tax’ is carefully maintained throughout Section 40(a).

The Court also rejected the argument that the surcharge on sales tax could be considered an appropriation by the State from KSBC under Section 40(a)(iib)(B), as the section does not include taxes.

The Court’s reasoning was based on a textual interpretation of Section 40(a)(iib), read in light of its legislative intent and the constitutional framework. The Court’s decision was unanimous.

The Supreme Court quoted the following 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.”
• “It is settled principle of interpretation that where the same Statute, uses different terms and expressions, then it is clear that Legislature is referring to distinct and different things.”

Key Takeaways

• Gallonage fees, license fees, and shop rentals paid by State Government undertakings are generally not deductible under Section 40(a)(iib) of the Income-tax Act, 1961.
• The term “exclusively” in Section 40(a)(iib) refers to the nature of the undertaking, not the number of licensees.
• Surcharges on sales tax and turnover tax are not fees or charges under Section 40(a)(iib) and are therefore deductible.
• The distinction between taxes and fees is crucial in interpreting Section 40(a)(iib).
• This judgment clarifies the scope of Section 40(a)(iib) and provides guidance on the deductibility of various payments made by State Government undertakings.

Directions

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

Development of Law

The ratio decidendi of this case is that gallonage fees, license fees, and shop rentals are disallowable under Section 40(a)(iib) of the Income-tax Act, 1961, while surcharge on sales tax and turnover tax are not. This judgment clarifies the scope of Section 40(a)(iib) and establishes that the term “exclusively” refers to the nature of the undertaking, not the number of licensees. It also reaffirms the distinction between “taxes” and “fees” under the Income-tax Act. This judgment clarifies that the term “exclusively” refers to the nature of the undertaking, not the number of licensees. It also reaffirms the distinction between “taxes” and “fees” under the Income-tax Act.

Conclusion

The Supreme Court’s judgment in the case of Kerala State Beverages Manufacturing & Marketing Corporation Ltd. vs. The Assistant Commissioner of Income Tax clarifies the scope of Section 40(a)(iib) of the Income-tax Act, 1961. The Court held that gallonage fees, license fees, and shop rentals are disallowable, while surcharge on sales tax and turnover tax are not. This ruling provides important guidance for State Government undertakings on the deductibility of various payments made to the State Government.