Supreme Court settles the nature of relationship between State Governments and lottery distributors for Service Tax applicability: Union of India vs. Future Gaming Solutions Pvt. Ltd. (2025) INSC 181 (11 February 2025)

Date of the Judgment: 11 February 2025
Citation: (2025) INSC 181
Judges: B.V. Nagarathna, J., Nongmeikapam Kotiswar Singh, J.
The Supreme Court addressed the critical question of whether lottery distributors act as agents of the state government or as independent entities. This determination is crucial for deciding the applicability of service tax under the Finance Act, 1994. The Court examined various agreements between the State of Sikkim and lottery distributors to ascertain the true nature of their relationship. The bench comprised Justices B.V. Nagarathna and Nongmeikapam Kotiswar Singh.

Case Background:

The dispute originated from a series of writ petitions filed by respondent-assessees challenging the levy of service tax on the sale of lottery tickets. These companies had agreements with the State of Sikkim to promote and sell both paper and online lottery tickets. The tax demands arose due to amendments made to the Finance Act, 1994, starting in 2012.

Timeline:

Course of Proceedings:

The High Court initially ruled in favor of the assessees, stating that service tax was not applicable to the sale of lottery tickets. This decision was challenged in the Supreme Court. During the pendency of the appeal, the Finance Act, 1994 was amended, leading to further litigation. The High Court consistently maintained that the activities of lottery distributors did not constitute a service and were beyond the purview of “taxable service” as defined in the Finance Act. These orders were challenged by the Union of India in the present appeals.

Legal Framework:

The core legal provisions at play in this case are centered around the Finance Act, 1994 and the Constitution of India.

✓ Finance Act, 1994: This act introduced service tax, which the government sought to apply to the lottery distributors. Amendments over the years attempted to clarify and expand the scope of taxable services to include activities related to lotteries.
✓ Section 65 of the Finance Act, 1994: Defined taxable services and business auxiliary services. Amendments to this section, including the introduction and deletion of explanations, played a crucial role in the dispute.
✓ Section 66B of the Finance Act, 1994: Levies a tax on the value of all services, other than those specified in the negative list.
✓ Section 66D of the Finance Act, 1994: Specifies the negative list of services, which initially included betting, gambling, or lottery. Subsequent amendments attempted to exclude certain lottery-related activities from this list.
✓ Article 246 of the Constitution of India: Divides legislative powers between the Parliament and State Legislatures, delineating subjects in the Union List (List I), State List (List II), and Concurrent List (List III).
✓ Article 248 of the Constitution of India: Grants residuary powers of legislation to the Parliament, allowing it to make laws on matters not enumerated in the Concurrent List or State List.
✓ Entry 62, List II of the Seventh Schedule: Grants State Legislatures the exclusive power to levy taxes on luxuries, including taxes on entertainments, amusements, betting, and gambling.
✓ Entry 97, List I of the Seventh Schedule: Grants Parliament the power to legislate on any matter not enumerated in List II or List III, including any tax not mentioned in either of those Lists.

Arguments:

Arguments by the Revenue (Union of India):

✓ The Lotteries (Regulation) Act, 1998, mandates that the organizing State must be the ultimate seller of lottery tickets, establishing an agency relationship between the State of Sikkim and the respondents-assessees.
✓ The State of Sikkim’s monopoly over the lottery business supports the agency interpretation.
✓ Agreements between the State and the respondents-assessees indicate a principal-agent relationship, focusing on clauses that determine whether the respondents-assessees are selling tickets on their own or on behalf of the State, and the allocation of risk and reward.
✓ For online lotteries, the agreements did not involve any physical transfer of tickets to the respondents-assessees. Instead, tickets were directly sold by the State to customers through computer terminals managed by the respondents-assessees.

Arguments by the Respondents-Assessees:

✓ The respondents-assessees operated independently on a principal-to-principal basis, and the agreement between the State and the respondents-assessees is structured in a way that reflects a buyer-seller relationship and not an agency.
✓ The respondents-assessees are mandated to pay a guaranteed minimum amount to the State Government irrespective of the number of tickets sold.
✓ Once the respondents-assessees purchase tickets from the State, they sell them onward at their discretion to sub-contractors or stockists. The sale proceeds exclusively belong to the respondents-assessees.
✓ The respondents-assessees bear the entire cost of marketing and advertising without reimbursement from the State Government.
✓ Lottery tickets constitute actionable claims, and thus transactions involving actionable claims are exempted under Section 66D of the Finance Act, 1994.
✓ Levy of service tax on lottery distributors infringes the State government’s exclusive power to legislate on “betting and gambling” under Entry 62 – List II of the Constitution.

Issues Framed by the Supreme Court:

1. Whether the impugned judgments of the High Court of Sikkim would call for any interference in these appeals?
2. If not, what order?

Treatment of the Issue by the Court: The following table demonstrates as to how the Court decided the issues

Authorities:

The court considered the following authorities:

✓ B.R. Enterprises vs. State of UP, (1999) 9 SCC 700 (Supreme Court of India): Discussed the nature and characteristics of lotteries as a form of gambling.
✓ R.M.D. Chamarbaugwalla vs. Union of India, AIR 1957 SC 628 (Supreme Court of India): Observed that gambling activities are res extra commercium.
✓ Sunrise Associates vs. Government of NCT of Delhi, (2006) 5 SCC 603 (Supreme Court of India): Categorized lottery tickets as actionable claims.
✓ State of Karnataka vs. State of Meghalaya, (2023) 4 SCC 416 (Supreme Court of India): Reserved the power to tax betting and gambling with the State Legislature.
✓ K. Arumugam vs. UOI, 2024 SCC Online SC 2278 (Supreme Court of India): Held that the purchase of lottery tickets is not a service in relation to promotion or marketing of service provided by the client.
✓ Hoechst Pharmaceuticals Ltd. vs. State of Bihar, (1983) 4 SCC 45 (Supreme Court of India): Observed that taxation is a distinct matter for purposes of legislative competence.
✓ Union of India vs. HS Dhillon, AIR 1972 SC 1061 (Supreme Court of India): Explained the function of Article 246(1) and the scope of Entry 97 – List I.
✓ State of Haryana vs. Suman Enterprises, (1994) 4 SCC 217 (Supreme Court of India): Held that a State-organized lottery requires the State to retain core control to protect public trust in the scheme.
✓ Khoday Distilleries Ltd vs. State of Karnataka, (1995) 1 SCC 574 (Supreme Court of India): Argued that the State can either conduct the monopoly business itself or do so through agents but cannot delegate its core functions to independent entities without compromising the monopoly.
✓ Godfrey Philips India Limited vs. State of Uttar Pradesh, (2005) 2 SCC 515 (Supreme Court of India): Emphasized that Parliament cannot use a residuary entry under Entry 97 – List I to impose taxes on subjects reserved for the States.
✓ Bhopal Sugar Industries Ltd. vs. STO, (1977) 3 SCC 147 (Supreme Court of India): Determined whether the contract was one of agency or sale.
✓ Sri Tirumala Venkateswara Timber and Bamboo Firm vs. Commercial Tax Officer, Rajahmundry, AIR 1968 SC 784 (Supreme Court of India): Observed that there is a distinction between a contract of sale and a contract of agency by which the agent is authorised to sell or buy on behalf of the principal.
✓ Moped India Ltd. vs. Assistant Collector of Central Excise, Nellore, (1986) 1 SCC 125 (Supreme Court of India): One of the questions was whether the commission allowed in respect of different varieties of mopeds to the dealers could be regarded as a trade discount or not.
✓ Alwaye Agencies vs. Deputy Commissioner of Agricultural Income Tax and Sales Tax, (AIR 1988 SC 1250) (Supreme Court of India): Examined whether under the agreement, the assessee firm was an agent of the said company, or whether under the agreement the assessee firm was really a purchaser of the goods which were booked by it.
✓ Snow White Industrial Corporation vs. Collector of Central Excise, (1989) 3 SCC 351 (Supreme Court of India): This Court considered the nature of the agreement being one of sale or one of sole selling agency
✓ M.S. Hameed vs. Director of State Lotteries, (2001) 249 ITR 186 (Ker) (Kerala High Court): Considered the question whether the amount received as commission or discount or any incentive or as a margin is income or earning which was taxable at the hand of the assessee concerned , coming under the p urview of Section 194G of the Income Tax Act .
✓ Ahmedabad Stamp Vendors Association vs. Union of India, (2002) 257 ITR 202 (Guj) (Gujarat High Court): Raised a question with regard to whether , the petitioners therein being stamp vendors were agent s of the State Government who were being paid commission or brokerage or whether the sale of stamp papers by the Government to the licensed vendors was on principal to principal basis involving a contract of sale.
✓ Bharti Cellular Limited (Now Bharti Airtel Limited) vs. Assistant Commissioner of Income Tax, (2024) 8 SCC 608 (Supreme Court of India): The assessees therein were cellular mobile service providers and the issue related to the liability to deduct tax at source under Section 194 -H of the Income Tax Act, 1961 on the amount which, as per the Revenue, was a commission payable to an agent by the assesse es under the franchise/distributorship agreement between the assesse es and the franchisees/distributors.

Judgment:

How each authority was viewed by the Court?

✓ B.R. Enterprises [CITATION]: The Court used this case to highlight that lotteries are a form of gambling and that even when conducted by the state, the element of chance remains.
✓ Sunrise Associates [CITATION]: The Court reiterated the categorization of lottery tickets as actionable claims based on this authority.
✓ K. Arumugam [CITATION]: The Court relied on this recent judgment to support the conclusion that the relationship between the State Government and the assessees is one of principal to principal, and therefore, service tax is not applicable.

What weighed in the mind of the Court?:

The Supreme Court’s decision was primarily influenced by the nature of the agreements between the State of Sikkim and the lottery distributors. The Court emphasized that the agreements indicated a principal-to-principal relationship rather than an agency. This was supported by the fact that the distributors purchased lottery tickets at their own risk, paid a guaranteed minimum revenue to the State, and bore the costs of marketing and advertising. Additionally, the Court considered the legislative competence and the constitutional provisions related to betting and gambling.

Logical Reasoning:

Issue: Whether the impugned judgments of the High Court of Sikkim would call for any interference in these appeals?

The Court’s reasoning included:

✓ Analyzing the agreements between the State of Sikkim and the lottery distributors.
✓ Examining the relevant provisions of the Finance Act, 1994, and amendments thereto.
✓ Considering the constitutional provisions related to the division of legislative powers.
✓ Reviewing previous judgments of the Supreme Court and High Courts on similar issues.

Key quotes from the judgment:

“That the assessee s who buy the lottery tickets on outright sale basis have the burden of select ing them through stockists for a profit as their business activity.”

“Thus, there is no promotion of the business of the State which conducts lotteries as an agent. Consequently, there is no principal -agent relationship , rather it is one of principal to principal.”

“There being no agency and no service rendered by the respondents -assessees herein as an agent to the Government of Sikkim, service tax is not leviable on the transactions between the purchaser of the lottery tickets ( respondents -assessees herein ) and the Government of Sikkim.”

Key Takeaways:

✓ The Supreme Court has definitively clarified that the relationship between state governments and lottery distributors in Sikkim is one of principal to principal, not principal to agent.
✓ Service tax under the Finance Act, 1994, is not applicable to the transactions between lottery distributors and the State Government of Sikkim.
✓ The judgment reinforces the importance of examining the substance of agreements and practices to determine the true nature of relationships in tax matters.

Development of Law:

The ratio decidendi of the case is that the relationship between the State Government of Sikkim and the lottery distributors is one of principal to principal, and therefore, service tax is not applicable. This decision reinforces the previous positions of law established in cases like K. Arumugam and Sunrise Associates.

Conclusion:

The Supreme Court dismissed the appeals filed by the Union of India, affirming the High Court’s decision that lottery distributors in Sikkim are not agents of the state government and are therefore not liable to pay service tax under the Finance Act, 1994. The Court emphasized that the agreements and practices indicated a principal-to-principal relationship.

Category:

Parent category: Finance Act, 1994
Child category: Section 65, Finance Act, 1994
Child category: Section 66B, Finance Act, 1994
Child category: Service Tax
Child category: Lottery
Child category: Agency Law

FAQ:

Q: What is the main outcome of this Supreme Court judgment?

A: The Supreme Court clarified that lottery distributors in Sikkim are not agents of the state government but operate as independent entities. Therefore, they are not liable to pay service tax under the Finance Act, 1994.

Q: How does this judgment affect lottery distributors in Sikkim?

A: Lottery distributors in Sikkim are no longer required to pay service tax on their transactions with the state government.

Q: What is the basis for the Supreme Court’s decision?

A: The Court based its decision on an analysis of the agreements between the State of Sikkim and the lottery distributors, as well as relevant legal provisions and precedents. The Court found that the agreements indicated a principal-to-principal relationship, not an agency.