Retrospective taxation risks: Supreme Court ruling and its economic fallout

Achieving the aspirational target of increasing per capita income to attain developed country status by 2047 requires the economy to grow at an average rate of more than 8 per cent per year over the next 23 years. At the prevailing incremental capital-output ratio, this requires the economy to enhance the investment rate to about 40 per cent of gross domestic product (GDP) from the present estimate of 32 per cent. 

 

This calls for, inter alia, an accommodating, stable, and forward-looking policy environment in which all three arms of the government — the legislature, executive, and judiciary — and the Union, state, and local governments coordinate policy formulation and implementation effectively.

 

To have an accommodating investment climate, it is important to ensure stable governance. Clarity in constitutional assignments, coordinated policy calibration, certainty in governance, and consistency in court judgments are important preconditions to creating a stable investment climate in the country.  The environment gets vitiated when judgments take a retrospective approach, as investors do not expect rules to change for past business activities. 

 

In this context, the significant adverse economic implications of the judgment by eight judges in the nine-judge Bench of the Supreme Court last year, led by then Chief Justice D Y Chandrachud, in the case of Mineral Area Development Authority & Anr. vs M/S Steel Authority of India & Anr, have largely gone unnoticed.

 

On July 25, 2024, overruling several earlier decisions, the Bench ruled that: (i) There is no overlap in the tax powers assigned to the Union and states under the Seventh Schedule; (ii) the royalty determined under the Mines and Minerals (Development and Regulation) (MMDR) Act and paid by the lessee to the lessor is not in the nature of a tax; (iii) while Entry 50 of the State List empowers the states to levy the tax on mineral rights subject to limitations placed by Parliament through laws relating to mineral development, the regulation placed under Entry 54 of the Union List does not apply to this power to levy the tax; and (iv) the regulation under Entry 54 does not limit the states’ power to levy a tax on land bearing minerals under Entry 49 of the State List.

 

A subsequent order by the Bench on August 14, 2024, further stated: (i) the states can levy or renew tax demands retrospectively from April 1, 2005; (ii) the interest and penalties levied on demands prior to July 25, 2024 will be waived; and (iii) payment for the retrospective tax demand made before July 25, 2024, may be staggered over a 12-year period commencing from April 1, 2026. Following the judgment, some states have initiated measures to levy taxes on minerals, with some states proposing to levy a tax on land as high as three times the value of the royalty.

 

Admittedly, the states have limited tax powers, and with the implementation of the goods and services tax (GST), their ability to raise revenue through taxes has significantly diminished. But, it is equally important to ensure that granting tax powers to them for this reason does not vitiate the business environment. 

 

In justification, the judgment quotes an earlier judgment on a different issue by Justice Jeevan Reddy, which stated: “The fact that under the scheme of our Constitution, greater power is conferred upon the Centre vis-à-vis the states does not mean that states are mere appendages on the Centre. Within the sphere allotted to them, states are supreme. The Centre cannot tamper with their powers. More particularly, the courts should not adopt an approach, an interpretation, which has the effect of or tends to have the effect of whittling down the powers reserved to the states.” 

 

While the above dictum is commendable and will be appreciated by federalists who want to safeguard state powers, it is important to take note of the economic implications of this judgment. In Shivashakti Sugars v Renuka Sugars (2017) judgment, the Supreme Court had emphasised that courts have a duty to undertake a detailed economic analysis of the impact of their decisions, and when multiple interpretations of the law are possible, the court must adopt the view that “…subserves the economic interest of the nation.”  Some of the economic pitfalls of the judgment were spelt out by Justice B V  Nagarathna in her lone dissenting judgment, but the adverse economic consequences of the judgment are even more pronounced.

 

First, the mines are leased by governments, and the royalty charged is equivalent to the administered price of the produce. It is a known fact that administered pricing in the case of a public monopoly is akin to an excise duty. Second, mines are not mobile and the states with mineral wealth can impose high taxes on these products, exporting the burden to residents of other states, as these are not destination-based taxes. Third, mineral products are basic inputs in industries, and exorbitant levels of extraction in the form of royalty, taxes on minerals, and taxes on mineral-bearing land are likely to result in significant cascading effects.  Since these are not part of GST, there will be no input-tax relief, and given that mineral products are essential inputs in manufacturing, heavy taxation could cause significant cascading and escalation in costs. Fourth, multiple taxation of minerals is likely to render Indian manufacturing non-competitive, prompting industry to either reduce dependence on domestic suppliers by resorting to imports or lobby for high tariff protection.  Resorting to imports could lead to the closure of mines and the loss of jobs. Alternatively, lobbying for higher tariffs would only hurt consumers.

 

The most pernicious impact of the judgment is the power to levy retrospective taxation. Retrospective changes in policies have previously plunged the economy into a quagmire of uncertainty, vitiating the investment climate. We had a bad experience with the Vodafone tax case, and a similar situation has emerged now. The retrospective taxation can create a climate of uncertainty for investors. The only hope is that the states will realise the pitfalls of heavy taxation on these inputs and avoid applying them retrospectively in the interest of fostering a more accommodating business environment.

 

The author is chairman, Karnataka Regional Imbalances Redressal Committee. The views are personal