CESS LEVIED ON SALES TAX FALLS WITHIN STATE’S AMBIT, SAYS SC

Why In News?

The Supreme Court upheld the power of State legislatures to levy an additional tax, surcharge or cess calculated on existing sales or purchase tax under the pre-GST regime. 

What Did The Supreme Court Decide?

• Validity of S. Kodar Upheld: The seven-judge Constitution Bench unanimously upheld the 1974 S. Kodar judgment, confirming that states have the constitutional authority to levy an additional tax or surcharge on top of existing sales tax.

• Enhancement of Tax Rate: The Court clarified that a surcharge calculated as a percentage of the sales tax payable is not a new category of tax. Instead, it is simply an enhancement of the rate of sales tax itself.

• Constitutional Competence: The levy falls squarely under Entry 54 of List II (State List) of the Seventh Schedule. Because it is a tax on the sale or purchase of goods, state legislatures were fully competent to enact it.

• Passing the Burden: The Court reaffirmed that a tax remains a sales tax even if the dealer is prohibited by law from passing the financial burden of the surcharge onto the consumer. The economic impact on the dealer does not change the legal nature of the tax.

• Disposed of as Academic: Since the Goods and Services Tax (GST) replaced the old indirect tax system in 2017, the court noted that the 27-year-old reference had become largely academic. However, the Bench chose to formally answer the legal question to clear up any lingering historical disputes.

What Is The Constitutional Framework On Taxation Powers?

Article 265: The Rule of Law in Taxation

• No Tax Without Authority: Article 265 dictates that "no tax shall be levied or collected except by authority of law". 

• Legality & Protection: The government cannot impose or collect any tax through an executive order or without a valid statute passed by a competent legislature. Tax laws must also not violate Fundamental Rights (such as Articles 14 and 19(1)(g)).  

Article 246 & The Seventh Schedule: Division of Powers

Tax-making powers are divided using the Seventh Schedule of the Constitution, which contains three lists:  

• Union List (List I): Empowers Parliament to legislate on taxes of national importance, such as income tax (excluding agricultural income), customs duties, corporation tax, and central excise.  

• State List (List II): Empowers State Legislatures to legislate on local/regional taxes, such as state excise, land revenue, and taxes on luxuries or amusements.  

• Concurrent List (List III): Does not feature concurrent taxation powers; instead, specific cooperative mechanisms like the Goods and Services Tax (GST) under Article 246A grant simultaneous power to both the Union and States to make laws regarding GST.  

Distribution of Tax Revenues (Articles 268–279)

India operates a fiscal federalism model where certain taxes are collected and shared:

• Article 270: Taxes levied and collected by the Union are shared between the Union and the States based on the recommendations of the Finance Commission (constituted under Article 280 every five years).  

• Article 271: Parliament can levy surcharges on certain taxes and duties exclusively for Union purposes. 

• Grants-in-Aid (Articles 273, 275, and 282): Provide financial assistance and revenue-deficit grants from the Consolidated Fund of India to states in need. 

Restrictions and Inter-Government Immunities

• Article 286: Places strict restrictions on State governments regarding the imposition of taxes on the import or export of goods outside of India or in the course of inter-state trade.

• Article 289: Grants mutual exemption where the property and income of a State government are immune from Union taxation.

• Freedom of Trade (Articles 301–304): Ensure that state taxation measures do not discriminate against or obstruct free trade and commerce across the country. 

What Are The Key Challenges In Fiscal Federalism?

Overuse Of Cesses By The Centre

• Shrinking Divisible Pool: The Centre's growing use of cesses and surcharges reduces the share of revenue that States receive. 

• Example: Successive Finance Commissions have flagged the rising share of cesses and surcharges in the Centre's gross tax revenue. Because these are not shared, States argue that their effective share of central taxes is lower than the recommended devolution.  

Shrinking State Tax Base After GST

• Limited Taxing Powers: After GST, States have few independent tax sources left, mainly petroleum, alcohol, stamp duty and land revenue.  

Shifting Judicial Positions

• Changing Precedents: Conflicting rulings over decades create uncertainty for taxpayers and governments.  

• Example: In Mineral Area Development Authority v. SAIL (2024), a nine-judge Bench overruled India Cement's view that royalty is a tax, and held that States can tax mineral rights. This showed how one ruling can unsettle a decades-old position.  

Transparency In Cess Use

• Fund Accountability: Questions remain about whether cess money is spent on its stated purpose and routed through the Consolidated Fund, as in the Punjab issue the Court left open. 

What Is The Way Forward?

Strengthen Fiscal Federalism

• Limit Cess Use: The Centre should reduce reliance on cesses and surcharges, or share part of them with States. 

• Cooperative Approach: Use the GST Council and the Inter-State Council to resolve tax disputes through dialogue.  

Improve Tax Clarity

• Clear Drafting: Legislatures should draft tax laws clearly to reduce litigation over their nature.  

• Timely Resolution: Constitutional questions should be decided faster, so references do not stay pending for decades. 

Transparent Use Of Cess Funds

• Accountability: All cess proceeds should pass through the Consolidated Fund and be audited for proper use. 

• Example: The CAG has in past reports flagged that parts of some central cess collections were not fully transferred to their dedicated funds, showing the need for strict accounting.  

Conclusion

The Supreme Court's ruling reaffirms that States could raise additional sales tax as an enhancement of their own tax, strengthening the principle that a tax's true nature decides who may levy it. In the GST era, the larger task is to protect States' fiscal space and ensure cesses are used fairly and transparently.

Source: THEHINDU