Decoding the Supreme Court judgment striking down the levy of IGST on Ocean freight

Introduction:

The issue regarding levy of IGST on ocean freight under reverse charge in case of CIF contracts has finally being resolved by Hon’ble Supreme Court of India. Hon’ble SC in case of Mohit Minerals [TS-246-SC-2022-GST] holds that the levy of GST such transaction would contradict the principle of composite supply as provided in Section 8 of the Central Goods And Services Act (‘CGST Act’) and be in violation of the scheme of the GST legislation. The view of the SC that the GST Council is a recommendatory body aiding the Government in enacting legislation on GST has also created a buzz amongst everyone and the same has also given a direction to a new round of discussion. The key aspects of the judgments are discussed herein below.

Brief Background:

With the introduction of the GST regime, the government issued the Notification No.8/2017- IGST(R) dated 28 June 2017 (‘impugned notification’) was issued by the Central Government on the recommendation of the Goods and Services Tax Council, in exercise of powers under Section 5(1), Section 6(1) and Section 20(iii)-(iv) of the Integrated Goods and Services Tax Act 2017 (‘IGST Act’), read with Section 15(5) and Section 16(1) of the CGST Act. Further, the Entry 9 of such notification levied an integrated tax (‘IGST’) at the rate of 5 per cent on the services of transportation of goods, in a vessel from a place outside India up to the customs station of clearance in India. Further, the Central Government issued Notification 10/2017 dated 28 June 2017 (‘impugned notification’) wherein Serial 10 of Notification 10/2017 categorized the recipient of services of supply of goods by a person in a non-taxable territory by a vessel to include an importer under Section 2(26) of the Customs Act 1962.

Section 5(1) of the IGST Act levies integrated tax (‘IGST’) on all inter-state supplies of goods and services or both. IGST can also be levied on goods imported into India on the value determined under Section 3 of the Customs Tariff Act 1975 at the point when customs duties are levied on the goods under Section 12 of the Customs Act 1962. Section 11 of the IGST Act stipulates that the place of supply of goods in the case of goods imported into India shall be the place of the importer. Section 13(9) of the IGST Act contemplates that the place of supply of services, in the case of transportation of goods shall be the destination of the goods.

The rationale given by the government to levy IGST on ocean freight was to provide level the playing field between foreign shipping lines and Indian shipping lines since the former were not required to charge any tax on the recipient of supply of service. Since the foreign shipping line or foreign exporters are located in a non-taxable territory, the Indian importer has to be taxed on a reverse charge basis since the service is consumed in India.

The validity of the aforesaid provisions was challenged before Hon’ble Gujarat HC [TS-29-HC-2020(GUJ)-NT] on inter-alia grounds that the impugned notifications create an element of double taxation in case where imports are made at Cost Insurance Freight terms (‘CIF’). As per the terms of CIF contracts the foreign export is liable to deliver the goods to the importer. The exporter also bears the cost of transportation and insurance till the place of import. The importer first pays IGST on ocean freight component of the import transaction since as ocean freight is included in the value of goods for the purpose of customs duty which the importer is liable to pay. Again the importer is liable to pay IGST separately on such ocean freight under reverse charge as deemed recipient of the service as provide in the impugned notification.

Hon,ble Gujarat HC declared Notification No.8/2017 and the Entry 10 of the Notification No.10/2017 as ultra vires the Integrated Goods and Services Tax Act, 2017 as ultra vires the Integrated Goods and Services Tax Act, 2017, as they lack legislative competency. The said decision of the Gujarat HC was challenged by the revenue before the Hon’ble SC.

Hon’ble SC agreed with the many of the contentions of the revenue. However, turned its decision in the favor of the respondents only on the ground that the impugned levy results in double taxation and the same is voilative of principle of composite supply as envisaged u/s 8 of the CGST Act. The key aspects of the decision of SC are discussed herein below.

Key aspects of the SC decisions

1. Constitutional architecture of GST

   Hon’ble SC discussed in detail the architecture of GST under constitution. It refers to the article 246A of the constitution which stipulates that both the Parliament and the State legislatures have the concurrent power to legislate on GST. Article 246A has a non-obstante provision which overrides Article 254. Article 246A does not provide a repugnancy clause. Unlike Article 254 which stipulates that the law made by Parliament on a subject in the Concurrent list shall prevail over conflicting laws made by the State legislature, the constitutional design of Article 246A does not stipulate the manner in which such inconsistency between the laws made by Parliament and the State legislature on GST can be resolved.

   SC also referred to the Articles 279A which provides enabling provisions for the constitution of the GST council. Article 279A also described in detail the matter on which the GST council can give recommendation to union and state government. Further, it also provided for manner of functioning of the council and voting rights of the members.

   SC observes that article 279A has rightly not been given an overriding effect over Article 246A. Article 246A vests the Parliament and the State legislatures with the power to enact laws on GST. This function, if delegated would amount to abdication of the Parliament’s constitutional function. Therefore, Article 246A cannot be made subject to Article 279A. SC opines that the concurrent power exercised by the legislatures under Article 246A is termed as a ‘simultaneous power’. Parliament has though bound itself to the recommendations of the GST Council by enacting certain provisions of the IGST Act and CGST Act. The recommendations by the GST Council are transformed into legislation on a combined reading of Article 279A and Sections 5,6, and 22 of the IGST Act 2017 and Sections 9,11, and 164 of the CGST Act.

2. Role of the GST council:

   Hon’ble SC in its judgment remarks that the role of the GST Council becomes very important considering the simultaneous legislative power conferred on Parliament and State legislatures.

   SC while referring to the parliamentary debates and the legislative history of the constitutional amendment, and the committee reports on Articles 246A and 279A, remarks that, recommendations of the GST Council are not based on a unanimous decision but on a three fourth majority of the members present and voting. SC also observes that the Centre has a one-third vote share in the GST Council coupled with the absence of the repugnancy provision in Article 246A indicates that recommendations of the GST Council cannot be binding.

   The provisions of the IGST Act and CGST Act which provide that the Union Government is to act on the recommendations of the GST Council must be interpreted with reference to the purpose of the enactment, which is to create a uniform taxation system. SC holds that the use of the phrase ‘recommendations to the Union or States’ indicates that the GST Council is a recommendatory body aiding the Government in enacting legislation on GST.

   SC remarks that the ‘recommendations’ of the GST Council are the product of a collaborative dialogue involving the Union and States. They are recommendatory in nature. To regard them as binding edicts would disrupt fiscal federalism, where both the Union and the States are conferred equal power to legislate on GST. SC opines that though the Government while exercising its rule-making power under the provisions of the CGST Act and IGST Act is bound by the recommendations of the GST Council. However, that does not mean that all the recommendations of the GST Council made by virtue of the power Article 279A (4) are binding on the legislature’s power to enact primary legislations.

3. Analysis of the various provisions

   1. Whether the Impugned notifications suffer from excessive delegation?

      SC has referred to the provision of article 269A and 286 of the Constitution of India. Articles 269A stipulates that Parliament may by law formulate principles for determining: (a) the place of supply and; (b) when the supply of goods or services or both takes place in the course of inter-State trade or commerce. Article 286(1) empowers Parliament to formulate the principles by law for determining when a supply of goods or services, or both, takes place (a) outside the state; and (b) in the course of import into or export outside the territory of India.

      Parliament enacted the IGST Act prescribing the principles as required under Articles 269A and 286(1). The provisions of the IGST Act deal with the levy and collection of tax (Section 5(1)), export of goods and services (Section 2(5) and 2(6)), import of goods and services (Section 2(10) and 2(11)), identification of the location of the supplier and recipient of services (Sections 2(14) and 2(15)), determination of the nature of inter-State supply (Section 7), supplies in territorial waters (Section 9), place of supply with respect to import to India and export from India (Section 11), and place of supply of services where the location of the supplier and recipient is in India and outside India (Sections 12 and 13).

      SC remarks that the legislature is required to perform its essential legislative functions. Once the skeletal structure of the policy is framed by the legislature, the details can emerge through delegated legislations. It is a settled position that the legislature cannot delegate its ‘essential legislative functions’. The essential legislative functions with respect to the GST law are the levy of tax, subject matter of tax, taxable person, rate of taxation and value for the purpose of taxation.

      The principles governing these essential aspects of taxation find place in the IGST Act. Section 5(1) identifies the subject matter of taxation as inter-State supplies of goods, services or both; Section 2(107) of the CGST Act identifies a taxable person; Section 5(1) provides a maximum cap of 40% as the rate of taxation; and Section 5(1) stipulates that the value of taxation be determined under Section 15 of the CGST Act.

      Section 2(98) of the CGST Act defines “reverse charge” as the liability of the recipient of the supply of goods or services or both to pay tax instead of the supplier. Section 2(93) of the CGST Act defines “recipient” with reference to three situations (i) when consideration is payable for the supply of goods or services or both; (ii) when no consideration is payable for the supply of goods; and (iii) when no consideration is payable for the supply of services. In the first situation, the recipient is the person by whom consideration is payable. In the second situation, the recipient is the person to whom (a) the goods are delivered or made available; or (b) possession or the use of the goods is given or made available.

      The CGST Act also stipulates a two-fold requirement for a recipient to be taxed on reverse charge basis, first the recipient must be a ‘person’ as defined under Section 2(84) of the CGST; and second the person is a “taxable person” only if registered or is liable to be registered under Section 22 or Section 24. Section 24(iii) of the CGST Act states that persons who are required to pay tax under reverse charge must be registered.

      In view of the above mentioned provisions of the GST law SC observes that the IGST and CGST Act clearly define reverse charge, recipient and taxable persons. Further, it opines that the essential legislative functions vis-à-vis reverse charge has not been delegated.

      Section 5(3) of the IGST Act provides the power to the Government with the recommendation of the GST Council to specify categories of supply of goods or services or both on which tax shall be paid on RCM by the recipient. The Government in exercise of its power u/s 5(3) of the IGST Act issued the Notification 10/2017 specifying the ‘categories of the supply’ which shall be subject to RCM. The notification, besides specifying the criteria, has also mentioned the corresponding recipient in those categories. Hon’ble SC observes that the IGST Act and the CGST Act defines reverse charge and prescribe the entity that is to be taxed for these purposes. Therefore, the SC draws a reference that the stipulation of the recipient in each of the categories in the impugned notification is only clarificatory. The Government by notification did not specify a taxable entity different from that which is prescribed in Section 5(3) of the IGST Act for the purposes of reverse charge.

   2. Charging Section: taxable person, taxable rate and manner of determining value

      SC by referring to the decisions of the Constitution Bench in Mathuram Agrawal v. State of Madhya Pradesh1999 (8) SCC 667 (“Mathuram Agrawal”) and further elaborated on by this Court in Gobind Saran Ganga Saran v. Commissioner of Sales Tax AIR 1985 SC 1041 (“Gobind Saran Ganga Saran”), observes that Section 5(1) of the IGST Act specifically identifies the four canons of taxation as referred to in these judgments:

      1. the inter-State supply of goods and services as the taxable event;

      2. the “taxable person” as the person on whom the levy is imposed;

      3. the taxable rate as such a rate notified by the Union Government on the recommendation of the GST Council, capped at forty per cent; and

      4. the taxable value as the value determined under Section 15 of the CGST Act.

      SC by referring to its own decisions in case of In CIT v. B C Srinivas Setty AIR 1981 SC 972 opines that the Section 5(3) and Section 5(4) of the IGST Act are inextricably linked with Section 5(1) of the IGST Act which is the charging provision. They must be construed together in determining the vires of the taxation.

      b.1 Taxable Person:

      Section 24(iii) of the CGST Act mandates persons required to pay tax under reverse charge to be compulsorily registered under the CGST Act. Section 2(107) of the CGST Act defines a “taxable person” to mean a person who is registered or liable to be registered under Section 24 of the CGST Act. Neither Section 2(107) nor Section 24 of the CGST Act qualify the imposition of reverse charge on a “recipient of service” and broadly impose it on “the persons who are required to pay tax under reverse charge”. Since the notification 10/2017 identifies the importer as the recipient liable to pay tax on a reverse charge basis under Section 5(3) of the IGST Act, the argument of the failure to identify a specific person who is liable to pay tax does not stand. The notification 10/2017 clearly specifies a taxable person who is liable to pay a reverse charge that is envisaged in the statute. Thus, the impugned notifications cannot be invalidated for an alleged failure to identify a taxable person.

      b.2 Taxable value

      Notification 8/2017 was amended to include the measure of taxable value to be ten per cent of the CIF value. Section 5(1) of the IGST Act enables the taxable value to be determined under Section 15 of the CGST Act. SC observes that Sections 15(4) and 15(5) enable delegated legislation to prescribe methods for determination of value, on the recommendations of the GST Council. Rules 27 to 31 of Chapter IV of the CGST Rules 2017, prescribe the manner of determining value of supply. Parliament has provided the basic framework and delegated legislation provides necessary supplements to create a workable mechanism. Rule 31 of the CGST Rules 2017 specifically provides for a residual power to determine valuation in specific cases, using reasonable means that are consistent with the principles of Section 15 of the CGST Act. This is where the value of the supply of goods cannot be determined in accordance with Rules 27 to 30 of the CGST Rules 2017.

      SC by referring the provisions of Rule 27 to 30 opines that the impugned notification 8/2017 cannot be struck down for excessive delegation when it prescribes 10 per cent of the CIF value as the mechanism for imposing tax on a reverse charge basis.

      b.3 Taxable event: Is an ocean freight transaction for import of goods a valid category of supply of services under Section 5(3) of IGST Act?

      It is observed by the Apex court that Section 7 of the CGST Act defines the term “supply” with a broad brush and provides for an inclusive definition. Section 7(1)(b) of the CGST Act considers import of services for a consideration to constitute “supply”. Section 7(1)(c) of the CGST Act captures any and all activities in Schedule 1 of the CGST Act, irrespective of whether they are made for a consideration. Additionally, Section 7(3) confers the power on the Central Government to specify which transactions are to be treated as a supply of goods and not a supply of services, and vice-versa. Section 7(4) of the IGST Act states that supply of services imported into India would be considered as a supply of services in the course of “inter-State trade or commerce”. Thus, an Indian importer could also be considered as an importer of the service of shipping which is liable to IGST on inter-state supply, if the activity falls within the definition of “import of service” for the IGST Act and CGST Act.

      The supplier, the foreign shipping line, in this case would be a non-taxable person. However, its services in a CIF contract for transport of goods would enter Indian taxable territory as the destination of such goods. The place of supply of shipping service by a foreign shipping line would thus be India.

      The term ‘supply’ has been defined in the IGST Act with reference to the CGST Act. Thus, the three conditions for “import of services” under Section 2(11)(iii) must be understood with reference to the provisions of the CGST and IGST Acts, including the provisions for determination of place of supply under Section 13(9) of the IGST Act. SC opines that Section 13(9) of the IGST Act creates a deeming fiction of place of supply of transportation services to be in India when the destination of goods is in India. In this case, it is clear the supplier of service- the foreign shipping line – is located outside India; and the place of supply is India. Accordingly, Section 13 of the CGST Act would be applicable to determine the time of such supply.

      The respondents have argued that the ocean freight transaction cannot be considered as “supply” since Section 7(1)(b) of the IGST act requires the import of service to be for a “consideration”. SC referred to the provisions of Section 2(31) of the CGST Act which defines ‘consideration’ to include payment made or to be made, in money or any other form, for the inducement of supply of goods or services to be made by the recipient or by any other person. SC opines that, in the case of goods imported on a CIF basis, the fact that consideration is paid by the foreign exporter to the foreign shipping line would not stand in the way of it being considered as a “supply of service” under Section 7(4) of the IGST Act which is made for a consideration, thereby constituting “supply of service” in the course of inter-state trade or commerce that can be subject to IGST under Section 5(1) of the IGST Act.

      b.3.1 Territorial nexus:

      SC while referring to its own judgment of GVK Industries v. Income Tax Officers 2011 (4) SCC 36 remarks that the parliament has the power to legislate over events occurring extra-territorially with a conditions that such an event must have a real connection to India.

      SC observes that the impugned levy on the supply of transportation service by the shipping line to the foreign exporter to import goods into India has a two-fold connection: first, the destination of the goods is India and thus, a clear territorial nexus is established with the event occurring outside the territory; and second, the services are rendered for the benefit of the Indian importer.

      Basis the above observations SC concluded that the transaction does have a nexus with the territory of India.

      b.3.2 Importer can be a recipient

      SC while interpreting the provisions of Sections 2(11) and 13(9) of the IGST Act, read with Section 2(93)(c) of the CGST Act opines that the import of goods by a CIF contract constitutes an “inter-state” supply which can be subject to IGST where the importer of such goods would be the recipient of shipping service.

      SC remarks that the above conclusion comports with the philosophy of the GST to be consumption and destination based tax. SC finds that the services of shipping are imported into India for the purpose of consumption that is routed through the import of goods. Although the consideration for shipping is payable by the foreign supplier to the foreign shipping line in CIF contracts, the price is consequently factored into the price of the shipment. The ultimate benefactor of the shipping service is also the importer in India who will finally receive the goods at a destination which is within the taxable territory of India. Thus, the meaning of the term “recipient” in the IGST Act will have to be understood within the context laid down in the taxing statute (IGST and CGST Act) and not by a strict application of commercial principles.

      SC opines that the Section 13(9) of the IGST Act read with Section 2(93)(c) of the CGST Act inherently create a deeming fiction of the importer of goods to be the recipient of shipping service.

      1. Applicability of Section 5(4) of IGST Act

      Section 5(4) of the IGST Act enables the Central Government to specify a class of registered persons as the recipients, thereby conferring the power of creating a deeming fiction on the delegated legislation. Hon’ble court remarks that even though the notification 10/2017 does not refer to the provisions of Section 5(4) of the CGST Act, the said notification would be valid u/s 5(4). SC forms such opinion based on the decision of its own in case of Titagarh Paper Mills v. Orissa State Electricity Boarda 1975 2 SCC 436 wherein it was held that as long as a source of power to legislate or issue a notification is available, the lack of a mention, an incorrect reference or mistake does not vitiate the exercise of such power.

      1. Composite Supply & Issue of Double Taxation

      In regards to the argument of the respondent regarding double taxation in case of CIF contracts hon’ble SC remarks that the Union of India cannot be heard to urge arguments of convenience – treating the two legs of the transaction as connected when it seeks to identify the Indian importer as a recipient of services while on the other hand, treating the two legs of the transaction as independent when it seeks to tide over the statutory provisions governing composite supply.

      Hon’ble SC observes that the supply of service of transportation by the foreign shipper forms a part of the bundle of supplies between the foreign exporter and the Indian importer, on which the IGST is payable under Section 5(1) of the IGST Act read with Section 20 of the IGST Act, Section 8 and Section 2(30) of the CGST Act. To levy the IGST on the supply of the service component of the transaction would contradict the principle enshrined in Section 8 and be in violation of the scheme of the GST legislation. Finally, the SC opined that while the impugned notifications are validly issued under Sections 5(3) and 5(4) of the IGST Act, it would be in violation of Section 8 of the CGST Act and the overall scheme of the GST legislation.

The Way forward

After, this favorable decision of the Apex court now it is the time to go back and relook our tax positions of the subject matter. There may be various situations such as one where the tax was paid and ITC was also availed; second where the tax was paid but no ITC availed and third where neither tax was paid nor ITC was availed. In the situation one and third, the taxpayer may not be required to take any action since there would be no adverse impact. However, in the second condition the tax payer may seek the possibility to claim refund of the tax paid. It would be pertinent to note that the Hon’ble Rajasthan HC in case of Shree Mahesh Oil Products vs. UOI [TS-336-HC(RAJ)-2021-GST] and Hon’ble Gujarat HC in Comsol Energy Private Limited [TS-1241-HC(GUJ)-2020-GST] allowed refund of IGST paid on Ocean Freight under reverse charge mechanism.

It would be import to see the limitation period for claiming refund of earlier years. However, by virtue of the provision of the article 265 of the Constitution of India, the taxpayer may plead that in absence of authority to levy IGST on ocean freight, the payment of such tax by the taxpayer be considered as deposit with government. Further, he may argue that such tax collected by the government without any authority to be refunded to the taxpayer.

Conclusion:

This decision of the SC has given a big relief to the taxpayers. It is expected from the government that the decision of the SC is accepted and they should provide a mechanism for the taxpayers to claim refund of the tax paid in cases where no ITC was claimed but the tax was duly deposited. The observation of the court that the recommendation of the GST council is recommendatory and not binding on the states has given a direction to a new round of discussion. There is no doubt that the role of GST council is of the vital importance for implementing harmonized tax structure of GST in the country. It would be important to see how different state government interprets such decision. Further, it is expected from the state governments and union government to work in a collaborative manner to implement a unified tax structure. Further, an effort should be made to implement a uniform policy of GST across all the states of India which lessens the litigation between the taxpayers and the government.

Article is written by CA Ankit Karanpuria. The author can be reached at karanpuriaankit@gmail.com

he views expressed in the above article are personal and for information purpose. The reader is required to take decision based on his own judgment and analysis. Writer shall not be responsible for any decision taken by the reader in the subject matter.