TMI Blog2010 (10) TMI 4X X X X Extracts X X X X X X X X Extracts X X X X ..... e Court). - the service tax imposed by Section 66 of the Finance Act, 1994 (as amended) on the value of taxable services referred to in Section 65(105)(zm) read with Section 65(12) of the said Act, insofar as it relates to financial leasing services including equipment leasing and hire-purchase is within the legislative competence of the Parliament under Entry 97, List I of the Seventh Schedule to the Constitution. Accordingly, the appeals are dismissed with no order as to costs. - Civil Appeal Nos. 9344-9351 of 2010 - - - Dated:- 26-10-2010 - KAPADIA S.H., AND RADHAKRISHNAN K.S. AND SWATANTER KUMAR JJ. Goolam E. Vahanvati, Attorney-General for India, Bishwajit Bhattacharya, Additional Solicitor-General, Arvind P. Datar, T.R. Andhyarujina, Senior Advocates (A. Raghunath, K. Swami, Ms. Prabha Swami, U.A. Rana, Ms. Mrinal Majumdar (for M/s. Gagrat co.), Satish Parasaran, Ms. A.M.P. Latha, S. Nanda Kumar, Achin Goel, R. Satish Kumar, V.N. Raghupathy, Rajiv Nanda, Rupesh Kumar, Mohd. Mannan, Rohit Sharma, Ajoy Singh, Judy James, Mihir Chatterjee, B. Krishna Prasad and Ms. Anil Katiyar, Advocates, with them, for the appearing parties. J U D GME N T S.H. KAPADIA, CJ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ver, vide Finance Act, 2001 service tax was imposed on "banking and other financial services". Vide Section 137(a) of the Finance Act, 2001, Section 65 of the Finance Act, 1994 was replaced by a new Section 65 which defined "banking and other financial services" vide clause (10). By virtue of the said definition under Section 65(10)(i), Parliament has sought to bring within the service tax net, transactions in the nature of financial leasing, equipment leasing and hire-purchase. By Section 65(72), the expression "taxable service" has been defined to mean any service provided to a customer, by a banking company or a financial institution including NBFC, in relation to banking and other financial services [See Section 65(72)(zm)]. Being aggrieved by the inclusion of hire-purchase and leasing services within the service tax net, the appellant herein challenged the amendment of 2001 as ultra vires the legislative competence of the Parliament. By the impugned judgment, the Madras High Court has dismissed the writ petition, hence, this civil appeal. Submissions 5. Mr. Arvind P. Datar, learned senior counsel appearing on behalf of the appellant(s), submitted that the effect of Art ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to levy service tax on a hire-purchase transaction or leasing transaction; except on the sale part in such transaction, which lay in the competence of the States under Entry 54, List II. In this connection, learned counsel placed reliance on the judgment of this Court in K.L. Johar and Co. v. Deputy Commercial Tax Officer [(1965) 2 SCR 112]. That, by the Constitution (Forty-sixth Amendment) Act in Article 366(29A)(c) and (d), hire-purchase/ leasing transactions were deemed to be sales and, consequently, the legislative competence in respect of hire part of the transaction was made over to the States. That, the Law Commission in its 61st Report stated that "the other alternative would be to transfer the entire power to the States. This will achieve a merger of the existing power of the States to tax the sale part and the new power to tax the hire part, which will enable state legislatures to provide for a tax on hire purchase price without demarcation". As a consequence of the Constitution (Forty-sixth Amendment) Act, the Parliament's competence to levy a tax on an activity relating to financial leasing services including equipment leasing and hire-purchase is constitutionally trun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aw Commission, particularly, in relation to the background in which clauses (c) and (d) of Article 366(29A) were recommended. The learned Attorney General invited our attention to the historical background of Article 366(29A) and the 61st Report of the Law Commission in support of his submission that a legal fiction was sought to be inserted in Article 366 in order to give an artificial extension to the definition of sale so as to include the power to levy sales tax even on the hiring part, and this is all that Article 366(29A) intended to do. From that, according to learned Attorney General, one cannot infer that Parliament has divested itself of the power to levy service tax. According to learned Attorney General, the question of service tax was not even present in the mind of Parliament when the Constitution (Fortysixth Amendment) Act was enacted and, therefore, reliance on the 61st Report of the Law Commission was completely misconceived. According to learned Attorney General, the reliance placed on Para 44 of the Bharat Sanchar Nigam Limited (supra) by the appellant(s) is completely misconceived because that judgment read in entirety recognizes the power of Union of India to l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Schedule of the Constitution and, thus, the same is constitutionally valid. Relevant provisions of the Finance Act, 2001 (as amended) 8. By the Finance Act, 2001, Section 65 of the Finance Act, 1994 stood substituted. For deciding this batch of cases, we are concerned with Section 65(10) read with Section 65(72)(zm), relevant parts whereof are quoted hereinbelow: "65. Definitions-In this Chapter, unless the context otherwise requires, (10) "banking and other financial services" means, the following services provided by a banking company or a financial institution including a non-banking financial company, namely: (i) financial leasing services including equipment leasing and hire-purchase by a body corporate; (72) "taxable service" means any service provided, (zm) to a customer, by a banking company or a financial institution including a non-banking financial company, in relation to banking and other financial services;" 9. The point to be noted is that whereas Section 65(10)/Section 65(12) defines what is "banking and other financial services", Section 65(72)(zm)/Section 65(105)(zm) indicates what is "taxable service". Section 65(12) read with Section 65(1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed payment or other valuable consideration; (e) a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration; (f) a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration, and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made;" 13. We also quote hereinbelow Articles 246 and 248 of the Constitution, which read as follows: "246 -Subject-matter of laws made by Parliament and by the Legislatures of States (1) Notwithstanding anything in clauses (2) and (3), Parliament has exclusive power to make laws with respect to any of the matters enumerated in List 1 in the Seventh Schedule (in this Constitution referred to as the "Union List"). (2) Notwithstanding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ancial institution" means any non-banking institution which carries on as its business an activity inter alia of financing, whether by way of making loans or advances or otherwise. Thus, Section 45-I(c) treats financing as an activity. Under Section 45-I(f), an NBFC is defined to mean a financial institution which is a company; a non-banking institution which is a company and which as a matter of business receives deposits or which lends in any manner. These activities are regulated by RBI under the 1934 Act. Thus, all NBFCs which carry on these activities as part of their business come within the purview of being financial institutions. Under Section 45-IA, no NBFC shall carry on the business of a non-banking financial institution without obtaining a certificate of registration from RBI. Under Section 45-JA the RBI is authorized in public interest to issue directions to NBFCs relating to income recognition, accounting standards, deployment of funds etc. and such NBFCs shall be bound to follow the policy so determined. Accordingly, under notification dated 2.1.1998 bearing No. 114, the deposit taking activities of NBFCs was sought to be regulated. Under the said notification, there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Section 45-I(c)(iii)(i)]. The above activities are financing activities encompassed under Section 45-I(c)(i) which in turn constitutes "rendition of services to its customer(s)" which is the taxable event under Section 65(105)(zm) of the Finance Act, 1994 (as amended). Apart from NBFCs, even banks through their subsidiaries with the approval of RBI can undertake equipment leasing, hire-purchase business and financial services. These are not direct lending activities. However, RBI treats them as services or facilities. The financial facilities are extended by way of equipment leasing or hire- purchase finance subject to approval of RBI [See Taxmann's RBI Instructions for Banking Operations 7th Edition page 224]. 19. The significance of the above circulars and guidelines is to show that the activities undertaken by NBFCs of equipment leasing and hire-purchase finance are facilities extended by NBFCs to their customers; that, they are financial services rendered by NBFCs to their customers and that they fall within the meaning of the words "banking and other financial services" which is sought to be brought within the service tax net under Section 66 of the Finance Act, 1994. One ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hire-purchase transaction. The former is exigible to service tax under Section 66 of Finance Act, 1994 (as amended) whereas the latter would be exigible to local sales tax/VAT. Funding or financing the transaction of equipment leasing and hire-purchase covers two different and distinct transactions. The activity of funding or financing by NBFC who is in the business of financing by giving loans, or equipment leasing or hire-purchase finance falls in the category of financial services rendered by NBFCs to their customers. It is an activity in relation to the hire-purchase or lease transaction. In this connection, as and by way of illustration we need to give an illustration which brings out the distinction between a "finance lease" and "operating lease". A finance lease transfers all the risks and rewards incidental to ownership, even though the title may or may not be eventually transferred to the lessee. In the case of "finance lease" the lessee could use the asset for its entire economic life and thereby acquires risks and rewards incidental to the ownership of such assets. In substance, finance lease is a financial loan from the lessor to the lessee. On the other hand an operati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "receivables" in their balance sheets. That, the activities of hire- purchase finance/equipment leasing undertaken by NBFCs come under the category of "para banking". That, in substance a finance lease, unlike an operating lease, is a financial loan (assistance/facility) by the lessor to the lessee. That, in the bailment termed "hire" the bailee receives both possession of the chattel and the right to use it in return for remuneration. On the other hand, equipment leasing is long term financing which helps the borrower to raise funds without outright payment in the first instance. Here the "interest" element cannot be compared to consideration for lease/hire which is in the nature of remuneration (consideration) for hire. Thus, financing as an activity or business of NBFCs is different and distinct from operating lease/hire-purchase agreements in the classical sense. The elements of the finance lease or loan transaction are quite different from those in equipment leasing/hire-purchase agreements between owner (lessor) and the hirer (lessee). There are two independent transactions and what the impugned tax seeks to do is to tax the financial facilities extended to its customers by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rvice tax gets attracted. The same view is reiterated broadly in the earlier judgment of this Court in Godfrey Phillips India Ltd. v. State of U.P. [(2005 (2) SCC 515] in which a Constitution Bench observed that in the classical sense a tax is composed of two elements : the person, thing or activity on which tax is imposed. Thus, every tax may be levied on an object or on the event of taxation. Service tax is, thus, a tax on activity whereas sales tax is a tax on sale of a thing or goods. Law as it stood before the Constitution (Forty-sixth Amendment) Act, 1982: 23. The principle that legislative entries must be given the widest interpretation is subject to the exception that where the entries use legal terms, they must be given their legal meaning. This principle was established in The State of Madras v. Gannon Dunkerley Co., (Madras) Ltd. [(1959) SCR 379] where it was held that in Entry 48 List II, Seventh Schedule of the Government of India Act, 1935, the words "sale of goods" had the same meaning which those words have in the Sale of Goods Act, 1930 ("1930 Act" for short). Thus, a legislature cannot extend its taxing power by defining the words "sale of goods" to cove ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Commercial Tax Officer [(1965) 2 SCR 112], this Court held that a hire-purchase agreement had two elements, an element of bail and an element of sale. When all the terms of the said agreement stood satisfied and the option to purchase was exercised, only at that stage sales tax would be exigible; but the legislature would have no power to tax such agreements till that stage was reached. Till that stage, a hire-purchase agreement is not a sale. It is important to note that under K.L. Johar's case, bailment termed as "hire" fell within the competence of the Parliament, the tax on sale of goods came within the competence of the State Legislature. Further, delivery which is the essence of bailment was not treated as an essential element of sale as a taxable event and as a result certain consequences as enumerated in the Statement of Objects and Reasons to the Constitution (Forty-sixth Amendment) Act ensued, as highlighted hereinbelow. 26. It is in view of the above problems, that the Constitution (Forty-sixth Amendment) Act, 1982 came to be enacted. The 61st Report of the Law Commission begins with the genesis. One of the points referred to in the Law Commission's Report related to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . However, two observations of the Commission may be noticed. The first is in para 25, page 32. It reads as follows: "The effect of the judgment in K.L. Johar's case is to reduce the tax base on which sales tax is payable. A tax on hire-purchase without sale can be levied on the full value of the hire-purchase transaction by the Union under the residuary power - entry 97 of Union List." 28. To the same effect is the observation of the Commission at page 37: "The power to tax hire-purchase within the State also vests in the Union under Union List, entry 97." 29. Thus, before the Constitution (Forty-sixth Amendment) Act, hire-purchase transaction could have been taxed by Union under Entry 97, List I but as a matter of policy Parliament brought in Article 366 (29A) as recommended by the Commission. The point to be noted is that reliance on the report [though it helps our above reasoning on some of the aspects] placed by the appellant (s) only shows that service tax was not in the mind of Parliament when the Constitution (Forty-sixth Amendment) Act stood enacted. It was not even in the mind of the Law Commission. That, as stated above, only on the principal juridical ground t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... always taxed by the States as part of the word "sale" in Entry 48/54 of List II. The object behind enactment of Article 366(29A) is to tax the composite price so that the full value of the hire-purchase price is taxed and to avoid the judgment in K.L. Johar's case whose implication was to narrow the tax base resulting in seepage of sales tax revenue. It is in that sense "splitting" of the contract needs to be understood. Thus, it cannot be said that Parliament divested itself of the power to levy service tax vide enactment of the Constitution (Forty-sixth Amendment) Act. Even in the Report of the Law Commission, it has been observed that "if a hire-purchase transaction results in a sale, sales-tax is undoubtedly leviable by the States. No doubt, it is difficult to determine the "sale price" for the purpose of the sales tax law but this has no bearing on the question of legislative competence" (page 26). Thus, reliance placed by the appellant(s) on the expression "splitting up" in K.L. Johar's case is misconceived because the "splitting up" referred to in K.L. Johar's case was, as stated above, in regard to valuation and not in regard to legislative competence. Whether the State ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch has not been done. One must also bear in mind that Article 366(29A) is essentially sales tax specific. It was brought in to expand the tax base which stood narrowed down because of certain judgments of this Court. That is the reason for bringing in the concept of "deemed sale" under which tax could be imposed on mere "delivery" on hire-purchase [See clause (c)] which expression is also there in the second limb of the said article. 33. To begin we would like to quote hereinbelow from the judgment of this Court the relevant observations in the case of The Second Gift Tax Officer, Mangalore v. D.H. Hazareth [AIR 1970 SC 999] on the doctrine of pith and substance: "The sovereignty of Parliament and the Legislatures is a sovereignty of enumerated entries, but within the ambit of an entry, the exercise of power is as plenary as any Legislature can possess, subject, of course, to the limitations arising from the fundamental rights. The entries themselves do not follow any logical classification or dichotomy. As was said in State of Rajasthan v. S. Chawla (1959) Supp 1 SCR 904 = (AIR 1959 SC 544) the entries in the Lists must be regarded as enumeratio simplex of broad categories. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts but the residuary power is vested in Parliament, such residuary power cannot be so expansively interpreted as to whittle down the power of the State Legislature. That might affect and jeopardise the very federal principle. The federal nature of the Constitution demands that an interpretation which would allow the exercise of legislative power by Parliament pursuant to the residuary powers vested in it to trench upon State legislation and which would thereby destroy or belittle State autonomy must be rejected . . ." 36. Now coming to the main point whether the whole field is covered by Entry 54 and that the levy of service tax is incompetent, it is important to note the language of Entry 97, List I and Article 248 except for the word "other" in Entry 97. This is because when one reads Entry 97 of List I with Article 246(1) it confers exclusive power first, to make laws in respect of matters specified in Entries 1 to 96 in List I and, secondly, it confers the residuary power of making laws by Entry 97. Article 248 does not provide for any express powers of Parliament but only for its residuary power. Article 248 adds nothing to the power conferred by Article 246(1) read with E ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mount representing as interest, i.e., the difference between the instalment paid towards repayment of the lease amount and the principal amount in such instalments paid (See Notification No. 4/2006 - Service Tax dated 1.3.2006). In other words, service tax is leviable only on 10% of the interest portion. (See also Circular F.No. B.11/1/2001-TRU dated 9.7.2001 in which it has been clarified that service tax, in the case of financial leasing including equipment leasing and hire-purchase, will be leviable only on the lease management fees/ processing fees/ documentation charges recovered at the time of entering into the agreement and on the finance/ interest charges recovered in equated monthly instalments and not on the principal amount). Merely because for valuation purposes inter alia "finance/ interest charges" are taken into account and merely because service tax is imposed on financial services with reference to "hiring/ interest" charges, the impugned tax does not cease to be service tax and nor does it become tax on hire- purchase/ leasing transactions under Article 366(29A) read with Entry 54, List II. Thus, while State Legislature is competent to impose tax on "sale" by legi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e service tax on financial leasing services including equipment leasing and hire-purchase is the subject matter of challenge. Legislative competence was not the issue before this Court in the Bharat Sanchar Nigam Limited's case. In that case, the principal question which arose for determination was in respect of the nature of the transaction by which mobile phone connections are enjoyed. The question was whether such connections constituted a sale or a service or both. If it was a sale then the States were legislatively competent to levy sales tax on the transaction under Entry 54, List II of the Seventh Schedule to the Constitution. If it was service then the Central Government alone had the legislative competence to levy service tax under Entry 97, List I and if the nature of the transaction partook of the character of both sale and service, then the moot question would be whether both the legislative authorities could levy their separate taxes together or only one of them. It was held that the subject transaction was a service and, thus, the Parliament had legislative competence to levy service tax under Entry 97, List I. In para 88 of the said judgment, this Court observed that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f List I in the face of challenges to the competence of the Parliament based on the entries in List II and on all the three occasions, this Court has held that the levy of service tax falls within Entry 97 of List I. The decisions are in the case of T.N. Kalayana Mandapam Association (supra), Gujarat Ambuja Cements Ltd. (supra) and All-India Federation of Tax Practitioners (supra). Conclusion 40. As stated above, the appellant(s) had moved the High Court in the writ petition challenging the validity of Section 66 of the Finance Act, 1994 on the value of taxable services referred to in Section 65(105)(zm) read with Section 65(12)(a)(i) without exhausting the statutory remedy. The contracts entered into by the appellant(s) with its customers were not vetted. There has been no adjudication under the Act in most of these cases and, therefore, we hereby direct the competent authority under the Finance Act, 1994 to decide the matter in accordance with the law laid down. Subject to above, for the afore-stated reasons, we hold that the service tax imposed by Section 66 of the Finance Act, 1994 (as amended) on the value of taxable services referred to in Section 65(105)(zm) read wit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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