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Constitutional challenge to levy of Service tax on Spectrum fee

JULY 04, 2016

By Anmol Anand

FINANCE Act, 2012 amended the Service Tax Law to define the long litigated definition of service while introducing a new regime of negative list. One of the legs of such definition also includes the concept of "Declared Services", that deems certain activities, prone to challenge, as 'services' per se to clear any ambiguity that may arise. In essence, government uses this wild card to bring within the ambit of service tax any "activity for consideration". Finance Act 2015 expanded such ambit by making all government services to business entities taxable unless specifically exempted. The government took a further leap by making assignment by government of right to use radio-frequency spectrum and natural resources taxable by way of Finance Act 2016, followed by clarificatory circulars and notifications. This paper discusses the constitutional validity of service tax on permission to exploit such resources, being a mandate and possibly a sovereign of the state, while also examining its impact on end users. These changes, under the guise of constitutional authority to tax are a possible hindrance to the fast growing Indian Economy and "ease of doing business" policy.

Negative List Regime

Finance Act 2012 made a paradigm shift in the service tax regime by introducing a "comprehensive approach" to tax all services, unless otherwise exempted/excluded. This was reflected upon the insertion of "Negative list of services" under Section 66D to Finance Act 1994 (hereinafter referred to as "the Act"). Before 2015, Section 66D(a) allowed services by government to escape service tax with a few exceptions. Those excepted government services were essentially available otherwise in the market by private players too, and hence were made taxable. One of such exceptions was "support services" provided by the government to business entities, which was omitted and substituted by "any service" by Finance Act 2015. The virtual effect of this incoherent amendment is to allow every service provided by government to business entity liable to service tax.

Section 66D(a) as effective today (i.e. after Finance Act 2015) generally excludes "services by Government or a local authority" from the service tax net, while excepting any service by government or local authority to business entity 1, thereby making the latter taxable. "Business Entity" means any person (individual, company, firm etc.) 2 ordinarily carrying out any activity relating to industry, commerce or any other business or profession 3. Thus, Section 66D(a) virtually would not exist if the exception to the general rule as aforementioned is not interpreted harmoniously with the principal matter 4. Courts would rather avoid an interpretation that would reduce the legislation to futility 5, and hence a logical gap must exist between Section 66D(a) and Section 66D(a)(iv), so that the relevant section in issue does not become futile. Therefore, the only logical gap that may be concluded to exist, would be that services provided by government to business entities would only be taxable if such services are also available in market by private players. This conclusion is also supported by the retention of other exceptions to section 66D(a) i.e. services by Department of Posts, services in relation to an aircraft or a vessel and services involving transport of goods or passengers. If the legislature intended otherwise, then it should have omitted the entire section 66D(a), so that all government services become taxable by virtue of the comprehensive approach as embodied in the service tax regime now, thereby making the virtuality, as aforementioned, a reality.

Declared Services (Section 66E of the Act)

Considering the reality that not all government services are taxable, it becomes imperative to understand the extent of the exception to the general rule under Section 66D(a) of the Act as aforementioned, in the context of introduction of "assignment by the Government of the right to use the radio-frequency spectrum and subsequent transfers thereof" 6 under the purview of service tax. Finance Act 2016 inserted section 66E(j) (hereinafter referred to as the "impugned section") to make assignment of right to use radio-frequency spectrum a "Declared Service".

"Declared service" means any activity carried out by a person for another person for consideration and declared as such under Section 66E of the Act 7. This definition is consistent with the definition of the word 'Service' under the Act 8. In essence, activities whose nature may otherwise suggest ambiguity are clarified expressly under "Declared services" to clear such confusion. For example, prior to 2012, in Home Solutions Retails (India) Ltd case 9 and Cinemax India Ltd case 10 , the validity of levy of service tax on "renting of immovable property" was upheld, while clarifying that renting of any property ipso facto would not amount to service for the purpose of service charge 11. The scope of levy of service tax on renting of immovable property had also became limited to cases where such activity was associated with business or commercial use 12. However, with the introduction of the "Declared services" concept in 2012, "renting of immovable property" 13 for whatever purpose was declared as "service" and hence the ratio in the aforementioned cases does not hold any significance. This act of legislature seems arbitrary at the very least, but such has been the pattern over the years in realm of taxes, because the authority to levy taxes lies absolutely with the legislature 14.

With "assignment by Government of the right to use radio-frequency spectrum" been declared as a service, the legislature has sought to expand its revenue sources beyond its authority, since services by Government or a local authority find place in negative list, as aforementioned. In this regard, its important to note that radio-frequency spectrum is a mandate of the Government and is not a commodity otherwise available for sale in the market. Radio-frequency spectrum are considered as natural resources, and Government as its legal owner 15. Because private players cannot alienate such property, such service should thus be exempt from the purview of service tax under section 66D(a), rather than being a declared service under section 66E(j).

It is clear thus far that two contradictory provisions now exist in the Finance Act 1994, that need be to construed harmoniously 16. The only possible way to reconcile the difference between the two provisions in issue is to consider taxing "assignment by Government of right to use the radio-frequency spectrum" when private players could also have a similar power of assignment. Allowing one of the two provisions to prevail over the other would reduce the other to a dead provision, which is against the principle of harmonious construction 17.

Meaning of 'service', "deemed sale" and "activity for consideration"

'Service' under section 65B(44) of the Act means any activity carried out by a person for another for consideration, and includes a declared service, but does not include an activity which constitutes a "sale/deemed sale" within the meaning of Article 366(29A) of the Constitution of India.

"Transfer of right to use any goods" including intangible property 18 is a deemed sale under Article 366(29A)(d) of the Constitution which can be taxed by State Government according to State List Entry 54 of Schedule VII of the Constitution. The most important attribute for constituting transfer of right to use goods as deemed sale as enunciated in the BSNL case 19 by the Supreme Court of India, is that the transferee gets effective control and possession of the goods for a specified period while the owner renounces such effective control for such period (20 years in the case of spectrum). In the case of "assignment of right to use radio-frequency spectrum", the property is the radio-frequency spectrum, the legal owner is the Government 20 and telecom companies are the transferees. Subsequent transfer of radio-frequency spectrum is also included in the impugned section, thereby indicating that telecom companies do not merely get a license to use such spectrum but also a legal right that is to the exclusion of the Government for the specified 20 year period, thus satisfying the BSNL judgment 21 . Therefore, declaring assignment of right to use radio-frequency spectrum, which is an intangible property, and levying service tax upon it, appears to be encroaching upon area reserved for the State Legislature. The Andhra Pradesh High Court in Nutrient Confectionary case 22 and the Madras High Court in AGS Entertainment Pvt. Ltd. case 23, are split with respect to concluding if a temporary transfer of right to use an intangible property is a sale or a service. Supreme Court's seal on this issue will also resolve the controversy as elaborated in this paper.

If "assignment of right to use radio-frequency spectrum" fails the deemed sale exception, then it should qualify as an "activity for consideration" to be able to survive a challenge. An activity cannot be considered as an "activity for consideration" unless it involves a "bargained for" concept i.e. at the desire of the person for whom the activity is done in exchange for a consideration 24. The "Spectrum Fee" paid by the telecom companies in the auction process for allocation of radio-frequency spectrum is in the nature of a license fee being a statutory obligation, which cannot be "bargained for". However, the government recently clarified that fee charged for getting a service in return has to be regarded as consideration and that service tax is leviable on any payment, in lieu of any permission or license granted by the Government 25. Therefore, a challenge to such circular for being overly broad is critical for challenging the impugned section.

Taxability of Government Service in discharge of Sovereign Function

The Supreme Court in Center for Public Interest Litigation 26 considered natural resources as national assets. It observed that the radio frequency spectrum was a scarce natural resource and hence a national asset, which the Government was empowered to distribute in consonance with the principles of equality and public trust. Moreover, in Secretary Ministry of Information & Broadcasting Govt. of India v. Cricket Assn. of Bengal 27, the Supreme Court expressly laid down that airwaves/frequencies were a public property and that they have to be used in the best interest of the society either by a central authority or by regulating the grant of licenses to other agencies, including private parties. Even the Directive Principles of State policy under Article 38 and 39 read with Article 297 of the Constitution of India articulates that the exploration, extraction and supply of natural resources are within the domain of governmental functions.

Furthermore, the Supreme Court in M.C. Mehta v. Kamal Nath 28 considered the public trust doctrine as enunciated in Illinois Central Railroad Co. v. People of the State of Illinois 29 while holding that the solemn duty of the Government was to protect the national interest and that natural resources must always be used in the interests of the country and not private parties. The Supreme Court in Center for Public Interest Litigation case 30, also held that alienation of scarce natural resource like spectrum was the burden of the Government to ensure that a non-discriminatory method was adopted for distribution and alienation, that would necessarily result in protection of national/public interest. Therefore, its clear that its a constitutional obligation of the Government of India to alienate rights with respect to radio frequency spectrum including the "right to use it" in the best interest of the nation.

Services provided by the Government in discharge of its sovereign functions are exempted from the purview of service tax. Such public services of Government include civil administration, defence, para-military, police, intelligence etc. In U.P v Jai Bir Singh 31, the Supreme Court observed that the concept of sovereignty in a constitutional democracy like India was to be regarded different from the traditional concept of sovereignty which was confined to 'law and order', 'defence', 'law making' and 'justice dispensation'. It was further observed that in India the sovereignty vests in the people, and that the Government was obliged to discharge its constitutional obligations as contained in the Directive Principles of the State Policy under the Constitution 32. It was also laid down that public welfare activities undertaken by the Government in discharge of its constitutional obligations should be treated as activities in discharge of its sovereign functions 33. Therefore, it can be deducted that assignment of radio frequency spectrum to telecom companies for its proper utilization, being a constitutional obligation as aforementioned, is a sovereign function and thus should not attract service tax. The Government has taken a stand in the past that activities assigned to and performed by the sovereign/public authorities under the provisions of any law are statutory duties and since they are in public interest they should not be treated as services provided for a consideration and hence not taxable 34. However, the Government recently changed its position and clarified that activity undertaken by it against a consideration constitutes a service and that it is immaterial whether such activities are undertaken as a statutory or mandatory requirement under the law 35. This again seems overly broad, considering that the Government under the same clarificatory circular has exempted services by way of grant of passport, visa, driving license, birth and death certificates although the same are procured by individuals upon consideration 36. Again, a challenge to such circular is critical for challenging the impugned section.

Conclusion

Assignment of right to use radio frequency spectrum embodies the classical dispute of being taxed either as a service or as a sale of intangible property. The finance minister in 2016 Budget Speech clarified that such activity is not to be regarded as a sale, thus clarifying doubts in the minds of telecom industries of what they can expect their future initial outlay to be before bidding in the auction for spectrum trading. The policy may be not harsh in long term for the telecom industry as their diminishing net present value for their investment can be borne by increasing their markup, which will however, impact the end user i.e. common man. In the short term, companies would have to come up with an extra 15% of the auction price upfront that will create hindrance and essentially disgrace the ease of doing business policy. The 2016 amendment as discussed in the paper, contradicts the negative list regime and creates an environment for litigation, which may be supplemented soon with the introduction of Goods and Service Tax regime.

The author graduated from ILS Law College in 2014 and Georgetown University Law Center in 2015 (Taxation LL.M.)

______________________________________________________________________________________________________

1. The Finance Act 1994, s. 66D(a)(iv) as amended by Finance Act 2015

2. The Finance Act 1994, s. 65B(37)

3. The Finance Act 1994, s. 65B(17)

4. Commissioner of Income Tax v. Indo– Mercantile Bank Ltd , 36 ITR 1 SC

5. B. Premanand v. Mohan Koikal , (2011) 4 SCC 266

6. The Finance Act 1994, s. 66E(j) as amended by Finance Act 2016

7. The Finance Act 1994, s. 65B(22)

8. The Finance Act 1994, s. 65B(44) - "service" means any activity carried out by a person for another for consideration, and includes a declared service...

9. Home Solutions Retails (India) Ltd. v. UOI - 2010-TIOL-341-HC-DEL-ST

10. Cinemax India Ltd. v. UOI - 2011-TIOL-535-HC-AHM-ST

11. Id

12. Supra note 9

13. The Finance Act 1994, s. 66E(a)

14. The Constitution of India, art. 265

15. Centre for Public Interest Litigation v. Union of India , (2012) 3 SCC 1

16. CIT v Hindustan Bulk Carriers - 2002-TIOL-845-SC-IT-LB

17. Id

18. Vikas Sales v. Commissioner of Commercial Taxes - 2002-TIOL-608-SC-CT-LB

19. Bharat Sanchar Nigam Ltd. v. Union of India - 2006-TIOL-15-SC-CT-LB

20. Supra note 15

21. Supra note 19

22. Nutrient Confectionary Co. Private Ltd. v. State of Andhara Pradesh , 2011-(040)-VST-0327-AP

23. ASG Entertainment Pvt. Ltd. v. Union of India, 2013 (32) STR 129 (Mad.)

24. Indian Contract Act 1872, s. 2(d) defines ‘Consideration' - "When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing something, such act or abstinence or promise is called a consideration for the promise."

25. Circular No. 192/02/2016-Service Tax, dated April 13, 2016

26. Supra note 15, at para 63

27. (1995) 2 SCC 161

28. (1997) 1 SCC 388

29. 146 U.S. 387 (1892), also see Jamshed Hormusji Wadia v. Board of Trustee, Port of Mumbai , (2002) 3 SCC 214; Intellectuals Forum Tirupathi v. State of A.P. , (2006) 3 SCC 549; Fomento Resorts and Hotels Limited v. Minguel Martins , (2009) 3 SCC 571. The court also referred to Joseph L. Sax, The Public Trust Doctrine in Natural Resources Law: Effective Judicial Intervention , 68 Mich. L. Rev. 471 (1970).

30. Supra note 15, at para 76

31. (2005) 5 SCC 1

32. Id

33. Id

34. Circular No. 96/7/2007-Service Tax, dated 23rd August, 2007

35. Circular No. 192/02/2016-Service Tax, dated April 13, 2016

36. Id

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