‘Royalty’: a Tax? : An Analysis of the Judicial Uncertainty and its Service Tax Implications

[Velpula Audityaa and Devansh Mani are both 4th year, B.A.LL.B (Hons.) Students at Symbiosis Law School, Pune]

Whether royalty payable on minerals extracted  as provided for under section 9 of the Mines and Minerals (Development and Regulation) Act, 1957 is in the nature of tax is one of the questions pending before a nine-judge bench of the Supreme Court. Depending on the outcome, there will be huge service tax implications for mining companies. This post seeks to analyse the conflicting judicial decisions which led to this matter and explore the current position in law regarding the same.

How the Conflict Arose

A seven-judge bench in the case of India Cement Ltd v. State of Tamil Nadu & Ors., AIR 1990 SC 85, laid down that royalty was a tax. Until then, almost all judicial decisions were of the view that royalty paid was not a tax. This decision influenced various High court and Supreme Court judgments over the next decade, causing a radical shift in judicial thought regarding the issue. This continued until 2004 when a five-judge bench of the Supreme Court in the case of The State of West Bengal v. Kesoram Industries Ltd. and Ors., AIR 2005 SC 1646, laid down that the decision in the India Cement was a typographical error and, having a “constitutional, legal and moral” obligation to correct the said error, stated that royalty was not a tax. As the smaller bench in Kesoram could not overturn the decision in India Cement, this resulted in a conflict between both the judgments. Therefore, in an order passed on 30 March 2011, the Supreme Court decided that a nin-judge bench had to inter alia hear and decide the present matter.

Examining the “typographical error”

The relevant paragraph in India Cement which was supposedly a typographical error is reproduced below:

“34. In the aforesaid view of the matter, we are of the opinion that royalty is a tax, and as such a cess on royalty being a tax on royalty, is beyond the competence of the State Legislature because Section 9 of the Central Act covers the field and the State Legislature is denuded of its competence under entry 23 of    list II. In any event, we are of the opinion that cess on royalty cannot be sustained under entry 49 of list II as being a tax on land. Royalty on mineral rights is not a tax on land but a payment for the user of land.”

The first line of paragraph 34 of the India Cement case, which was claimed to have been an error by the five-judge bench of Kesoram, stated that royalty was tax. The reason cited was that the first sentence said “royalty is tax” and the last sentence said “royalty is not tax on land, but a payment for the user of the land”. They also stated that by way of the discussion in paragraph 22 and 31 it was obvious that the Court agreed that ‘royalty’ was not a tax.

The authors are of the view that the two sentences in paragraph 34 by themselves are not contradictory to each other, and are to be viewed as two different legs to an argument.

Discussion in previous paragraphs of the India Cement ruling

“22. It was also contended on behalf of the respondent State of Tamil Nadu by Mr.  Krishnamurthy Iyer that it (cess on royalty) could also be justified under entry 49 of list II of the 7^th Schedule as taxes on lands and buildings. This, however, cannot be accepted.”

(same paragraph) “But in the instant case, royalty being that which is payable on the extraction from the land and cess being an additional charge on that royalty cannot, by the parity of the same reasoning, be considered to be a tax on land.”

(same paragraph) “Construing the said entry, this Court observed that entry 49 list II contemplated a levy on land as a unit and the levy must be directly imposed on land and must bear a definite relationship to it.”

The Court, by citing a precedent, established that Entry 49 of List II referred to a tax on land directly as a unit. What Mr. Krishnamurthy Iyer (on behalf of Tamil Nadu State) claimed was that cess on royalty was a tax directly on land.

“23. … It is, therefore, not possible to accept Mr. Krishnamurthy Iyer’s submission and that a cess on royalty cannot possibly be said to be a tax or an impost on land. Mr. Nariman is right that royalty which is indirectly connected with land cannot be said to be a tax directly on land as a unit. …”

From a careful reading of the aforementioned text, the first sentence establishes two things: (i) the Court’s disagreement towards Mr. Krishnamurthy Iyer’s submission that cess on royalty was a tax on land as under Entry 49, List II, and (ii) cess on royalty cannot be said to be a tax or an impost on land. The second sentence establishes that royalty, being indirectly connected with land, cannot be said to be a tax directly on land, thereby not falling within the definition of “Taxes on Land”.

Mr. Nariman observed that royalty was not a tax directly on land as a unit and, as such, would not constitute a tax under Entry 49 of List II (Tax on Land and buildings). The Court further went on to note that there were other types of taxes. Since royalty was payable on a proportion of the minerals extracted, and the impugned tax (i.e. cess on royalty) would consequentially be on that proportion, it would constitute a different tax, and not the same as Entry 49. The Court still had not expressly laid down that Royalty was Tax.

Coming to paragraph 27, the relevant passages are extracted below:

“27. Our attention was drawn to the decision of the division bench judgment of the High Court of Mysore in M/s. Laxminarayana Mining Co., Bangalore v. Taluk Dev. Board, AIR 1972 Mys 299. There speaking for the court, one of us, Venkataramiah J. of the Mysore High Court, as the learned Chief Justice then was..”

(same paragraph) “At p. 306 of the said report, it was held that royalty under Section 9 of the Mines and Minerals Act was really a tax.

28. To the similar effects are the observations of the High Court of Patna in AIR 1965 Pat 491.”

In paragraph 27, the Court mentioned a case of the Mysore High Court i.e. Laxminarayana case, which was in fact authored by one of the judges who heard the present case (E.S. Venkataramaiah, CJ), and mentioned the proposition that royalty was a tax, as had been laid down in that judgment. It has to be noted that the Court never stated anything which would remotely suggest that this proposition was wrong. This stands fortified by the fact that by quoting from a case which a judge hearing the present matter authored, they only wished to give authority to the proposition laid down in the case. It also cited another case (Laddu Mal v. State of Bihar, AIR 1965 Pat 491) which stated that royalty was tax. Again, it never stated anything which would suggest that the Court did not agree with the view that royalty was tax. 

By considering all the paragraphs quoted above, it would now be wise to analyze paragraph 34, which was claimed to have been a typographical error. The first sentence of paragraph 34 was the reiteration of their discussion in paragraphs 27 and 28, and the last sentence is the reiteration of the discussion in paragraph 23, which stated that royalty was not a tax on land. What it meant by the last sentence was that royalty was not a tax on land as it was not directly related to land (as required by Entry 49), but a different kind of tax: a tax on the mineral extracted by the individual/entity, which would be indirectly related to land (fortified by the discussion in paragraph 27 and 28). The word ‘payment’ used in the last sentence was used synonymously with the word tax.

Subsequent Position

After the India Cement case and before the Kesoram case, there are two important decisions in this context. One is the case of Orissa Cement Ltd v. State of Orissa and Ors., AIR 1991 SC 1676, and the other is the case of State of MP v. Mahalaxmi Fabric Mill Limited, AIR 1995 SC 2213. The first case was when the possibility of a typographical error was contemplated, but the Court was quick to dismiss it on finding no merit, and said that if royalty was a tax it would be a tax on mineral rights. In the second case also, a Division Bench laid down that the fact that royalty was a tax “logically flowed” from the arguments laid down in the previous paragraphs. However, the Mahalaxmi Fabric Mill case was overruled in the Kesoram case.

Current Position

As of now, pending the decision of the nine-judge bench, in the authors’ opinion the current law of the land is the India Cement case, keeping in mind various constitutional principles. Therefore, as of now, ‘royalty’ is tax, and the law should be applied as it is, until the nine-judge bench overrules the current position and lays down a different one.

Service Tax Implications

Service tax in India was introduced by way of Finance Act, 1994, as a tax under Entry 97 of List I of Schedule VII of the Constitution. The service tax regime in India saw a massive change by the introduction of the negative list (section 66D) in the Finance Act, 2012. Prior to that, since service tax’s introduction in 1994 until 2012, it was an ever increasing, but exhaustive list of services, which could be subject to service tax. Section 66D(a)(iv) specifically provided that “support services” provided by the Government or local bodies to business entities could be subject to service tax. However, with effect from 1 April 2016, “support services” were changed to “all services” provided by the Government or local bodies to business entities, thereby bringing granting of mining leases to business entities within its purview, on which service tax would have to be computed by reverse charge mechanism by the business entity.

We understand that the Department has issued service tax show cause notices on various mining companies on royalty paid between 1 April 2016 (marking the amendment of “support services” to “all services”) until the introduction of the GST regime (30 June 2017). The same is the subject matter of litigation in various High Courts across the country.

If the India Cement case is upheld, then it will be a major win to mining companies in terms of service tax on royalty between 01 April 2016 to 30 June 2017, as service tax cannot be levied upon taxes (vide Circular No. 192/02/2016-S.T.).

However, pending litigation, the authors suggest payment of tax under protest, as the same can be refunded if the Supreme Court reaffirms that royalty is tax. Even if the matter is decided after one year, the refund claims would not be hit by the one year limitation under Sec.11B of the Central Excise Act, 1944 read with Sec. 83 of the Finance Act, 1994, due to the decision in Commissioner of Central Excise Commissionerate, Chandigarh-1 Vs. Ind. Swift Lands Ltd. [(2017) 78 taxmann.com 209 (Punjab & Haryana)].

Implications under the GST Regime

“Any service” provided by the Government or local bodies to business entities has continued to be excluded from the exemption list under the GST regime, under Entry No. 01 in the Exemption List. As per the FAQs issued by the Directorate General of Mines Safety (DGMS) on the Mining Sector, GST is applicable on royalty and is to be deducted by reverse charge mechanism.

Concluding Remarks

It is therefore, in the authors’ view, undisputed that the Court meant to say that royalty was a tax. However, there are a few things to be considered when we look at the decision in India Cement case. First of all, they had cited decisions which said that royalty was a tax. Thereafter, they even acknowledged the fact that there were decisions which stated that royalty was not a tax. However, they never expressly negated that argument. It was mentioned and left at that. It has to be noted that up until the India Cements case, almost all decisions unanimously held that royalty was not a tax.

The second aspect to be kept in mind is that the conclusion arrived at, i.e. royalty is tax, was based on a Karnataka HC judgment (Laxminarayana case), which further relied upon another High Court case (Laddu Mal case). Therefore, the basis for claiming that ‘royalty’ was a tax was not duly supported. However, it is well established that merely because a decision was badly argued, inadequately considered or fallaciously reasoned, it does not lose its authority, as laid down in State of Gujarat v. R.A. Mehta (2013) 3 SCC 1.

Whatever may be the decision, the stakes are large. Therefore, the judgment in the present matter would be a very welcome one in order to settle the confusion in jurisprudential thought.

– Velpula Audityaa & Devansh Mani