M J Antony: Tax liability of state agencies

OUT OF COURT

While Article 285 of the Constitution exempts Union property from state taxation, Article 289 exempts state property from taxation. However, income derived by the state from governmental or non-governmental activities could be taxed by a law made by Parliament. Since the state governments indulge in several non-governmental activities creating revenue, a question often arises whether such pursuits could be brought within the tax net. Governments set up corporations, authorities and other bodies which embark upon endeavours that are not exactly sovereign. The tax liability of such authorities set up by the government was discussed recently by the Supreme Court in Adityapur Industrial Area Development Authority vs Union of India.

The Adityapur authority was set up under a Bihar statute to provide planned development of industrial area, for promotion of industries and other allied matters. It can acquire, hold and dispose of properties. All monies received by it shall be credited to its funds kept in a nationalised bank. It is headed by a chairman and a director board of five people. When the income tax authorities issued notice to the authority, it challenged the action by way of a writ petition in the Jharkhand High Court. When it was dismissed, the authority appealed to the Supreme Court, again without success.

Before 2003, the Income Tax Act had exempted the income of such authorities dealing with housing, planning, development or improvement of cities, towns and villages. However, the Finance Act of 2002 omitted this clause in Section 10 and limited the exemption to panchayats and municipalities. The argument of the Adityapur authority was that it was a local authority and it carried on trade or business on behalf of the state. Therefore, it was entitled to the exemption under Article 289 of the Constitution.

The Central government countered this argument, stating that unless the income generated by the agency or instrumentality of the state directly and remained the income of the state, the agency, whether corporation, company or an authority could not claim exemption from Union taxation. What is exempted under Article 289 from Union taxation is the income of the state and not the income of any authority under the state, it was argued.

The Supreme Court stated that the question that has to be asked in such situations is whether the income of the authority is the income of the state. In this case, the authority derived and managed its own funds. It was a separate legal entity. Therefore, there was no doubt that the income of the authority was not the income of the state.

Although there have been few cases on this point after the 2003 amendment to the Income Tax Act, the principles laid down by the Supreme Court in Andhra Pradesh State Road Transport Corporation vs Income Tax Officer supports the present view. In that case, the question arose as to whether the income derived from the trading activity of the road transport corporation established under a state law was the income of the state. If it was so, it would be exempt from Union taxation.

After a detailed consideration of the constitutional provisions, the Supreme Court ruled that the property as well as the income in respect of which exemption is claimed under Article 289(1) of the Constitution must be the property and income of the state. The crucial question to be asked is: is the income derived by the state from its transport activities the income of the state? If a trade or business is carried on by the state departmentally or through its agents appointed exclusively for that purpose, there would be no difficulty in holding that the income made from such trade or business is the income of the state. However, if one is dealing with trade or business carried on by a corporation established by a state, the answer would be different. It was decided in the Andhra Pradesh case that the income of the transport corporation was not the income of the state.

In this case also, though the authority was created under an Act of the legislature, it was still an authority that had a distinct personality of its own, having perpetual succession and a common seal, with powers to acquire, hold and dispose of property. In contrast, the Supreme Court struck down the tax on the Delhi civic authority's income from property/municipal taxes for violation of Article 289(1) of the Constitution in New Delhi Municipal Council vs State of Punjab. On the other hand, there are a few cases in which the state attempted to impose levy on Union authorities like the port trusts or the food corporation. The ultimate outcome of all these cases is that the corporate veil, or the lack of it, should be examined before fixing the liability. After the 2003 amendment and this judgement, more state entities stand to lose exemption from central taxes.