Larger Bench to review compensatory tax

The state governments' power to impose a "compensatory tax" on goods imported from other states in the context of the constitutional doctrine of freedom of trade will be examined by a five-judge Constitution Bench of the Supreme Court.

A Division Bench last week found that two sets of earlier judgments over four decades were incongruent in their interpretation of the compensatory tax. It has asked the Chief Justice to set up a Constitution Bench to sort out the differences.

The issue arose in a batch of appeals moved by Jindal Strips Ltd and some associations of industries in Haryana against the state local area development tax. The petitioners brought raw materials from outside and sold the finished products mostly outside Haryana. Only the manufacture was done in Haryana.

Two years ago, the state made the law to impose an entry tax on all goods brought in. The state wanted to distribute the tax collected among the local bodies for the development of local areas. The industries challenged this law as violative of Article 301 of the Constitution, guaranteeing freedom of trade.

Judgments laid down by the apex court till 1995 relied upon the concept of "compensatory tax". Taxes are compensatory and valid if they are collected to provide certain service to the tax paying units.

A working test for deciding whether a tax is compensatory or not is to enquire "whet-her the traders are having the use of certain facilities for the better conduct of their business and paying not patently much more than what is required for providing the facilities."

Though this rule held the field for a long time, a change came about in 1995 when a three-judge Supreme Court Bench widened the concept of the compensatory tax in the Bhagat Ram vs Commissioner of Tax case.

According to this decision, even if there is a "substantial or even some link" between the tax and the facilities extended to such dealers, directly or indirectly, the levy would be valid. Rulings of the Supreme Court, which followed this decision further expanded the idea.

The petitioners in the present case argued that if the latter view prevailed, the states could impose the tax because there was hardly any difference between taxes in general and compensatory levy.

No tax can then impinge on the freedom of trade ordained in Article 301. They further argued the Haryana Act talked of development of local areas, not development of roads or trading facilities to benefit the taxpayers.

The apex court found that the parameters of the judicial concept had got "blurred" by the latter decision in the Bhagat Ram case. Thus the principle should be clarified by a larger Bench, it said and referred the matter to the Chief Justice.