The Constitutional Validity of Deeming Fictions Under the GST Law

[Prakruthi Jain is a 3rd year B.A., LL.B. (Hons.) student at NALSAR University of Law, Hyderabad]

The Goods and Services Tax (“GST”) was introduced by the 101st Amendment Act in 2016. This was followed by the introduction of the four Acts, i.e., the Central Goods and Services Tax Act (“CGST”), the Integrated Goods and Services Act (“IGST”), the Union Territories Goods and Services Tax Act (UTGST) and the Goods and Services Tax (Compensation to States) Act (SGST) in 2017. This post deals with the provisions of the IGST Act (“the Act”) pertaining to the imposition of tax on transactions where the place of supply is outside India but has been taxed using the Reverse Charge Mechanisms and deeming fiction to bring them under the ambit of taxable transactions.

Interplay of GST with the Constitutional Scheme for Taxation

Article 246A of the Constitution of India empowers the Parliament to provide for GST over the interstate supply of goods or services or both. Further, Article 269A(5) of the Constitution empowers the Parliament to formulate principles to ascertain the place of supply in matters of interstate transactions, upon which subject matter, the GST council shall make recommendations by virtue of Article 279A(4)(c) of the Constitution. Heed must be paid to the constitutional restrictions placed on the taxing powers of the State under Article 286 of the Constitution of India, more specifically, the restriction on taxing transactions where the supply takes place outside India. These restrictions have an overriding effect over any power conferred to tax, either by the Constitution or any other statute, and any such power must be read in harmony with the restrictions, which would otherwise render the provision nugatory. Several attempts have been made under the various GST Acts to impose taxes on transactions taking place outside India using the cloak of a deeming fiction, thereby subverting the constitutional restriction imposed under Article 286 of the Constitution.

GST is a destination-based consumption tax, in contrast with the principle of taxation based on origin, as clarified by the Central Board of Indirect Taxes and Customs. This implies that the incidence and liability of the tax shall accrue on the person who consumes the goods or services and where such consumption occurs. Therefore, it is imperative to note that although the Constitution empowers the Parliament to lay down the principles determining the place of supply, such a power cannot be interpreted to mean that the Parliament is empowered to impose a tax on transactions taking place outside India. In other words, when consumption is taking place outside India, it cannot be treated as a local supply by playing around with the principles of determining the place of supply. Such an interpretation would defeat the purpose of the Constitutional embargo on taxing extra-territorial transactions and fall foul of the inherent nature of GST as a destination-based tax. Therefore, such extra-territorial application of laws does not fall within the constitutional framework nor the ambit of the statutory scheme of the GST regime.

The doctrine of pith and substance would enable us to look beyond the bare provisions of the Act and understand the true nature of supply and place of supply of a given transaction. In actuality, if a good or service is being consumed outside the territory of India and such consumption is sought to be taxed, severe doubts would be raised about the legislative competence of the Parliament to tax such transactions as no such power can be derived from Article 269A of the Constitution nor the charging sections of the Acts. Such a provision would also fall foul of the principle of equality enshrined under Article 14 of the Constitution in as much as it “seeks to impose on the same class of property, persons, transactions or occupations similarly situate incidence of taxation, which leads to an obvious inequality”, as held in V. Venugopala Ravi Varma Rajah v. Union Of India.

Constitutionality of Section 13(8)(b) of the IGST Act

The recent controversy regarding the status of intermediary services vis-à-vis exports is an example of the above debate. The controversy deepened with the split verdict by the Bombay High Court in the case of Dharmendra M Jani v. Union of India. In this case, the constitutional validity of section 13(8)(b) of the IGST Act was questioned. The IGST Act governs the imposition of GST over the transactions pertaining to the inter-state supply of goods and services, with intricate provisions dealing with what constitutes an inter-state supply, determination of place of supply, exemption to exports, and exceptions to the general principle that the place of supply is the place of the recipient of goods and services as the GST is a destination-based consumption tax. Section 13(8)(b) refers to intermediary services. It provides for one such exception to the general rule of determining the place of supply, implying that in the case of intermediary services, the supplier’s location shall be the place of supply as opposed to the recipient’s location. Therefore, in the case of intermediary services, even if the Indian intermediary service provider is providing services to customers outside India, it would not amount to an “export” and would be taxable under the IGST Act as an inter-state supply. This was challenged as being violative of the rights under Article 19(1)(g) as it places an “unreasonable restriction upon the right of the petitioner to carry on trade and business,” among other grounds.

The reasoning adopted by the GST Council to keep intermediary services outside the purview of the tax benefit afforded to “exports” is to eliminate ambiguity about the place of supply in relation to goods and services and to prevent loss of revenue to the government. Furthermore, it was justified on the basis that such a provision would incentivize foreign companies to set up manufacturing in India to enjoy the tax benefits on exports, thereby bolstering the ‘Make in India’ program. On the contrary, the Parliamentary Committee Report titled the “Impact of Goods and Services Tax (GST) on Exports” noted that 18% IGST was attracted on transactions where the primary supplier and buyer are both located outside India, and only the intermediary was located in India by virtue of the legal fiction created under section 13(8)(b) of the IGST Act. This is contrary to the arguments advanced in favor of such imposition. Consequently, the report recommended that intermediary services be treated as exports, or in the alternative, an exemption must be provided for Indian intermediaries against the levy of IGST under section 6(1) of the IGST Act. Pursuant to this, vide a notification, Indian intermediaries were exempt from payment of IGST on transactions where both the buyer and the seller were located outside India.

Another concern raised by such a levy is double taxation, or the problem of tax on tax. Although the intermediary in India is paying tax on the commission earned by it, GST would also be levied on the Indian importer who purchases the said goods. Additionally, in cases where the recipient of the supply is located outside the Indian territory, it would be impossible to pass on the tax burden onto the consumer, which violates both the indirect element as well as the destination-based consumption nature of the levy.

Judicial Inconsistency in Interpreting the Deeming Fictions

Although the courts have hesitated to strike down the provision related to intermediary services in Dharmendra M Jani, Material Recycling Association and Genpact India Pvt. Ltd., the controversy of deemed legal fiction is not restricted to intermediaries.

Section 13(9) of the IGST Act provides for a similar legal fiction, wherein “the place of supply of services of transportation of goods, other than by way of mail or courier, shall be the place of destination of such goods.” The Parliamentary Committee report made similar remarks on this categorization and noted “the disparity in respect of freight payable during export of goods since engaging a foreign-based shipping line does not attract GST whereas engaging an Indian shipping line would be liable to GST”. The Committee recommended that provisions of the IGST Act should be accordingly amended to “bring exports made by Indian shipping lines at par with foreign shipping lines and provide a level playing field for Indian Shipping Industry.” Although the place of supply under section 13(9) of the IGST Act is the location of the supplier, a three-judge bench of the Supreme Court, in the recent case of Union of India v. Mohit Minerals Pvt. Ltd., held that even if the supplier of such services is located outside India while the recipient being in India, such a transaction can attract a levy of IGST. This is because “the destination of the goods is India, and thus, a clear territorial nexus is established with the event occurring outside the territory; and second, the services are rendered for the benefit of the Indian importer.”

Therefore, what can be seen is a trend to blow hot and cold at the same time to interpret the taxing provisions according to the benefit of the State’s revenue, in utter disregard of the Constitutional architecture governing the taxing powers of the State. Such a situation leads to uncertainty and runs contrary to the purpose of the “One Nation, One Tax” regime, which is aimed at uniformity, consistency, global competitiveness, and transparency.

Prakruthi Jain

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