IMPORTANT POINTS
1. Doctrine of ‘direct and immediate effect’ of the impugned law on trade and commerce under Article 301 of the Constitution and the working test enunciated for deciding whether a tax is compensatory or not will continue to apply and the test of ‘some connection’ is not good law.
2. Whenever a law is impugned as violative of Article 301 of the Constitution, the Court has to see whether the impugned enactment facially or patently indicates quantifiable data on the basis of which the compensatory tax is sought to be levied.

Headnote:(i) Constitution of India—Articles 301 to 304—Compensatory tax—Nature and character—Working test for deciding whether a tax is a compensatory or not is to enquire whether trade is having use of certain facilities for better conduct of its business and paying not patently much more than what is required for providing the facilities—Doctrine of ‘direct and immediate effect’ of operation of impugned law on freedom of trade and commerce in Article 301.
       Held : Article 301 states that subject to the other provisions of Part-XIII, trade, commerce and intercourse throughout India shall be free. It is not freedom from all laws but freedom from such laws which restrict or affect activities of trade and commerce amongst the States. Although Article 301 is positively worded, in effect, it is negative as freedom correspondingly creates general limitation on all legislative power to ensure that trade, commerce and intercourse throughout India shall be free. Article 301, therefore, refers to freedom from laws which go beyond regulations which burdens, restricts or prevents the trade movement between States and also within the State. Since “freedom” correspondingly imposes “limitation”, we have the doctrine of “direct and immediate effect” of the operation of the impugned law on the freedom of trade and commerce in Article 301 as enunciated in Atiabari Tea Co., AIR 1961 SC 232. Article 301 is, therefore, not only an authorization to enact laws for the protection and encouragement of trade and commerce amongst the States but by its own force creates an area of trade free from interference by the State and, therefore, Article 301 per se constitutes limitation on the power of the State. Article 301 is, however, subject to the other provisions of Articles 302, 303 and 304. It states that subject to other provisions of Part-XIII, trade, commerce and intercourse throughout India shall be free. Article 301 is binding upon the Union Legislature and the State Legislatures, but Parliament can get rid of the limitation imposed by Article 301 by enacting a law under Article 302. Similarly, a law made by the State Legislature in compliance with the conditions imposed by Article 304 shall not be hit by Article 301. Article 301 thus provides for freedom of inter-State as well as intra-State trade and commerce subject to other provisions of Part-XIII and correspondingly it imposes a general limitation on the legislative powers which limitation is relaxed under the following circumstances:
       a)Limitation is relaxed in favour of the Parliament under Article 302, in which case Parliament can impose restrictions in public interest. Although the fetter is limited enabling the Parliament to impose by law restrictions on the freedom of trade in public interest under Article 302, nonetheless, it is clarified in clause (1) of Article 303 that notwithstanding anything contained in Article 302, the Parliament is not authorized even in public interest, in the making of any law, to give preference to one State over another. However, the said clarification is subject to one exception and that too only in favour of the Parliament, where discrimination or preference is admissible to the Parliament in making of laws in case of scarcity. This is provided in clause (2) of Article 303.
       b)As regards the State Legislatures, apart from the limitation imposed by Article 301, clause (1) of Article 303 imposes additional limitation, namely, that it must not give preference or make discrimination between one State or another in exercise of its powers relating to trade and commerce under Entry 26 of List-II or List-III. However, this limitation on the State Legislatures is lifted in two cases, namely, it may impose on goods imported from sister State(s) or Union Territories any tax to which similar goods manufactured in its own State are subjected but not so as to discriminate between the imported goods and the goods manufactured in the State [See Clause (a) of Article 304]. In other words, clause (a) of Article 304 authorizes a State Legislature to impose a non-discriminatory tax on goods imported from sister State(s), even though it interferes with the freedom of trade and commerce guaranteed by Article 301. Secondly, the ban under Article 303(1) shall stand lifted even if discriminatory restrictions are imposed by the State Legislature provided they fulfill the following three conditions, namely, that such restrictions shall be in public interest; they shall be reasonable; and lastly, they shall be subject to the procurement of prior sanction of the President before introduction of the bill.
       Broadly, the above analysis of the scheme of Articles 301 to 304 shows that Article 304 relates to the State Legislature while Article 302 relates to the Parliament in the matter of lifting of limitation, which, as stated above, flows from the freedom of trade and commerce guaranteed under Article 301. Article 304 also confers upon the State Legislature power to lift the limitations imposed on it by Article 301 and clause (1) of Article 303. This aspect is important because the doctrine of “direct and immediate effect” which is mentioned in Atiabari Tea Co. emerges from the concept of “limitation” embodied in Article 301. It is this doctrine of direct and immediate effect which constitutes the basis of the working test propounded vide para 19 in Automobile Transport, AIR 1962 SC 1406. Therefore, whenever the law is impugned as violative of Article 301, the Courts will have to examine the effect of the operation of the impugned law on the inter-State and the intra-State movement of goods, which movement constitutes an integral part of trade.(Paras 29 to 32)
       (ii) Constitution of India—Articles 301 to 304 and 145—Haryana Local Area Development Tax Act, 2000—Constitutional validity of the Act challenged—Petitioners case that the Haryana Act is violative of Article 301 and is not saved by Article 304 and that the Act in fact seeks to levy sales tax on inter State sales, which is outside the competence of State Legislature—Appellant is an industry manufacturing products within the State of Haryana—Raw material is purchased from outside the State—Finished products are sent to other States on consignment basis or stock transfer basis—No sales tax is paid on input of the raw material—No sales tax is paid on the export of finished products—Impugned Act is enacted to provide for levy and collection of tax on the entry into a local area of the State—According to the referral order, after 1995, concept of compensatory tax which is judicial evolved is blurred by reason of decisions in Bhagatram’s case 1995 Supp (1) SCC 673 and Bihar Chamber of Commerce case, (1996) 9 SCC 136—Whether test of ‘some connection’ as propounded in Bhagatram’s case is applicable to the concept of compensatory tax—(No)—Judgments in Bhagatram’s case and Bihar Chamber of Commerce overruled.
       Held : The concept of compensatory taxes was propounded in the case Automobile Transport, AIR 1962 SC 1406 in which compensatory taxes were equated with regulatory taxes. In that case, a working test for deciding whether a tax is compensatory or not was laid down. In that judgment, it was observed that one has to enquire whether the trade as a class is having the use of certain facilities for the better conduct of the trade/business. This working test-remains unaltered even today. As stated above, in the post 1995 era, the said working test propounded in the Automobile Transport, AIR 1962 SC 1406 stood disrupted when in Bhagatram’s case, 1995 Supp. (1) SCC 673, a Bench of three Judges enunciated the test of “some connection” saying that even if there is some link between the tax and the facilities extended to the trade directly or indirectly, the levy cannot be impugned as invalid. In our view, this test of “some connection” enunciated in Bhagatram’s case is not only contrary to the working test propounded in Automobile Transport’s case but it obliterates the very basis of compensatory tax. We may reiterate that when a tax is imposed in the regulation or as a part of regulatory measure the controlling factor of the levy shifts from burden to reimbursement/recompense. The working test propounded by a Bench of seven Judges in the case of Automobile Transport and the test of “some connection” enunciated by a Bench of three Judges in Bhagatram’s case cannot stand together. Therefore, in our view, the test of “some connection” as propounded in Bhagatram’s case is not applicable to the concept of compensatory tax and accordingly to that extent, the judgments of this Court in Bhagatram Rajeevkumar v. Commissioner of Sales Tax, M.P., 1995 Supp. (1) SCC 673 and State of Bihar v. Bihar Chamber of Commerce, (1996) 9 SCC 136 stand overruled.(Paras 46 & 47)
       In our opinion, the doubt expressed by the referring Bench about the correctness of the decision in Bhagatram’s case, 1995 Supp. (1) SCC 673 followed by the judgment in the case of Bihar Chamber of Commerce was well-founded. We reiterate that the doctrine of “direct and immediate effect” of the impugned law on trade and commerce under Article 301 as propounded in Atiabari Tea Co. Ltd. v. State of Assam, AIR 1961 SC 232 and the working test enunciated in Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan, AIR 1962 SC 1406 for deciding whether a tax is compensatory or not vide para 19 of the report, will continue to apply and the test of “some connection” indicated in para 8 of the judgment in Bhagatram Rajeevkumar v. Commissioner of Sales Tax, M.P., 1995 Supp. (1) SCC 673 and followed in the case of State of Bihar v. Bihar Chamber of Commerce, (1996) 9 SCC 136 is, in our opinion, not good law. Accordingly the constitutional validity of various local enactments which are the subject matters of pending appeals, special leave petitions and writ petitions will now be listed for being disposed of in the light of this judgment.(Paras 49 & 50)
       (iii) Constitution of India—Articles 301 to 304—Compensatory tax—Generic concept—Difference between exercise of Taxing and Regulatory Power—Parameters of compensatory tax—Difference between ‘a tax’, ‘ a fee’ and ‘a compensatory tax’.
       Held : Tax is levied as a part of common burden. The basis of a tax is the ability or the capacity of the taxpayer to pay. The principle behind the levy of a tax is the principle of ability or capacity. In the case of a tax, there is no identification of a specific benefit and even if such identification is there, it is not capable of direct measurement. In the case of a tax, a particular advantage, if it exists at all, is incidental to the States’ action. It is assessed on certain elements of business, such as , manufacture, purchase, sale, consumption, use, capital etc. but its payment is not a condition precedent. It is not a term or condition of a licence. A fee is generally a term of a licence. A tax is a payment where the special benefit, if any, is converted into common burden. On the other hand, a fee is based on the “principle of equivalence”. This principle is the converse of the “principle of ability” to pay. In the case of a fee or compensatory tax, the “principle of equivalence” applies. The basis of a fee or a compensatory tax is the same. The main basis of a fee or a compensatory tax is the quantifiable and measurable benefit. In the case of a tax, even if there is any benefit, the same is incidental to the government action and even if such benefit results from the government action, the same is not measurable. Under the principle of equivalence, as applicable to a fee or a compensatory tax, there is an indication of a quantifiable data, namely, a benefit which is measurable. A tax can be progressive. However, a fee or a compensatory tax has to be broadly proportional and not progressive. In the principle of equivalence, which is the foundation of a compensatory tax as well as a free, the value of the quantifiable benefit is represented by the costs incurred in procuring the facility/services which costs in turn become the basis of reimbursement/ recompense for the provider of the services/facilities. Compensatory tax is based on the principle of “pay for the value”. It is a sub-class of “a fee”. From the point of view of the Government, a compensatory tax is a charge for offering trading facilities. It adds to the value of trade and commerce which does not happen in the case of a tax as such. A tax may be progressive or proportional to income, property, expenditure or any other test of ability or capacity (principle of ability). Taxes may be progressive rather than proportional. Compensatory taxes, like fees, are always proportional to benefits. They are based on the principle of equivalence. However, a compensatory tax is levied on an individual as a member of a class, whereas a fee is levied on an individual as such. If one keeps in mind the “principle of ability” vis-a-vis the “principle of equivalence”, then the difference between a tax on one hand and a fee or a compensatory tax on the other hand can be easily spelt out. Ability or capacity to pay is measurable by property or rental value. Local rates are often charged according to ability to pay. Reimbursement or recompense are the closest equivalence to the cost incurred by the provider of the services/ facilities. The theory of compensatory tax is that it rests upon the principle that if the government by some positive action confers upon individual(s), a particular measurable advantage, it is only fair to the community at large that the beneficiary shall pay for it. The basic difference between a tax on one hand and a fee/compensatory tax on the other hand is that the former is based on the concept of burden whereas compensatory tax/fee is based on the concept of recompense/reimbursement. For a tax to be compensatory, there must be some link between the quantum of tax and the facility/services. Every benefit is measured in terms of cost which has to be reimbursed by compensatory tax or in the form of compensatory tax. In other words, compensatory tax is a recompense/reimbursement. In the context of Article 301, therefore, compensatory tax is a compulsory contribution levied broadly in proportion to the special benefits derived to defray the costs of regulation or to meet the outlay incurred for some special advantage to trade, commerce and intercourse. It may incidentally bring in net-revenue to the government but that circumstance is not an essential ingredient of compensatory tax. Since compensatory tax is a judicially evolved concept, understanding of the concept, as discussed above, indicates its parameters. To sum up, the basis of every levy is the controlling factor. In the case of “a tax”, the levy is a part of common burden based on the principle of ability or capacity to pay. In the case of “a fee”, the basis is the special benefit to the payer (individual as such) based on the principle of equivalence. When the tax is imposed as a part of regulation or as a part of regulatory measure, its basis shifts from the concept of “burden” to the concept of measurable/quantifiable benefit and then it becomes “a compensatory tax” and its payment is then not for revenue but as reimbursement/recompense to the service/facility provider. It is then a tax on recompense. Compensatory tax is by nature hybrid but it is more closer to fees than to tax as both fees and compensatory taxes are based on the principle of equivalence and on the basis of reimbursement/recompense. If the impugned law chooses an activity like trade and commerce as the criterion of its operation and if the effect of the operation of the enactment is to impede trade and commerce then Article 301 is violated.(Paras 37 to 42)
       (iv) Constitution of India—Articles 301 to 304—Compensatory tax—Challenge to the validity of an Act as violative of Article 301 of the Constitution—Burden on the State to show that payment of compensatory tax is a reimbursement/recompense for benefit provided or to be provided to its payer.
       Held : Whenever a law is impugned as violative of Article 301 of the Constitution, the Court has to see whether the impugned enactment facially or patently indicates quantifiable data on the basis of which the compensatory tax is sought to be levied. The Act must facially indicate the benefit which is quantifiable or measurable. It must broadly indicate proportionality to the quantifiable benefit. If the provisions are ambiguous or even if the Act does not indicate facially the quantifiable benefit, the burden will be on the State as a service/facility provider to show by placing the material before the Court, that the payment of compensatory tax is a reimbursement/recompense for the quantifiable/measurable benefit provided or to be provided to its payer(s). As soon as it is shown that the Act invades freedom of trade it is necessary to enquire whether the State has proved that the restrictions imposed by it by way of taxation are reasonable and in public interest within the meaning of Article 304(b).(Para 43)

JUDGMENT

Kapadia, J.—By order dated 26.9.2003, the referring Bench of Hon’ble Ruma Pal, J. and P. Venkatarama Reddy, J. doubted the correctness of the view taken in M/s Bhagatram Rajeevkumar v. Commissioner of Sales Tax, M.P. & others1 relied on in the subsequent decision of this Court in the case of State of Bihar & Ors. v. Bihar Chamber of Commerce & Ors.2. Accordingly, all the matters were ordered to be placed before the Hon’ble the Chief Justice for appropriate directions and accordingly, the matter has come to the Constitution Bench to decide with certitude the parameters of the judicially evolved concept of “compensatory tax” vis-a-vis Article 301. The referral order is in the case of Jindal Strips Ltd. & Anr. (now known as Jindal Stainless Ltd.) v. State of Haryana & Ors.3 under Article 145(3).

2. For this purpose, we are required to examine the source from which the concept of compensatory tax is judicially derived, the nature and character of compensatory tax and its parameters in the context of Article 301.

3. In a batch of appeals, the constitutional validity of the Haryana Local Area Development Tax Act, 2000 has been challenged on two grounds: (1) that, the Act is violative of Article 301 and is not saved by Article 304; and (2) that, the Act in fact seeks to levy sales tax on inter-State sales, which is outside the competence of the State Legislature. However, the referral order is confined to the above-mentioned first question.

4. Jindal Strips Ltd. is an industry manufacturing products within the State of Haryana. The raw-material is purchased from outside the State. The finished products are sent to other States on consignment basis or stock transfer basis. No sales tax is paid on the input of the raw material. Similarly, no sales tax is paid on the export of finished products.

5. The impugned Act came into force w.e.f. 5th May, 2000 to provide for levy and collection of tax on the entry of goods into the local areas of the State for consumption or use therein. The Act is enacted to provide for levy and collection of tax on the entry into a local area of the State, of a motor vehicle for use or sale, and of other goods for use or consumption therein. The Act seeks to impose entry tax on all goods brought into a “local area”. The entire State is divided into local areas. The Act covers not only vehicles bringing goods into the State but also vehicles carrying goods from one local area to another. However, those who pay sales tax to the State are exempt from payment of entry tax. Ultimately, the entry tax only falls on concerns, like Jindal Strips, which, by virtue of the provisions of the Central Sales Tax Act, 1956, pay sales tax on purchase of raw-material and sale of finished goods to other States and do not pay sales tax to the State of Haryana. This is the context in which the challenge to the Act under Article 301 has been made. At this stage, we may point out that prior to September 30, 2003, section 22 stated that the tax collected under the Act shall be distributed by the State Government amongst the local bodies to be utilized for the development of local areas. However, on 30th September, 2003, section 22 was amended clarifying that the tax levied and collected shall be utilized for facilitating free flow of trade and commerce.

REASONS FOR THE REFERRAL ORDER:

6. In Atiabari Tea Co. Ltd. etc. V. State of Assam & Ors.4, it was held that taxing laws are not excluded from the operation of Article 301, which means that tax laws can and do amount to restrictions on the freedoms guaranteed to trade under Part-XIII of the Constitution. However, the prohibition of restrictions on free trade is not an absolute one. Statutes restrictive of trade can avoid invalidation if they comply with Article 304(a) or (b)5.

7. In Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan6, it was held that only such taxes as directly and immediately restrict trade would fall within the purview of Article 301 and that any restricti

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2006 Supreme(SC) 235

Cases Referred (15)