GST on Royalty – Mining Sector | A 360 degree analysis

GST ON ROYALTY PAID FOR MINING OPERATIONS:

1. What is Royalty?

Royalty in law means payment made to the owner of certain types of rights by those who are permitted by the owners to exercise such rights. The rights concerned, for example, are – literary, copyright, patent etc. and include rights in mineral deposits. Although mineral deposits have nothing in common with the fruits of intellectual and artistic endeavors except that they are often exploited by persons other than the owners upon payment of Royalties, it forms a vital part of a fiscal regime and an important means of revenue realization for the Government.

Going through the definition of ‘royalty’ as laid down under Rajasthan Minor Minerals Concession Rules, 2019, it precisely, as per Section 2 (xliv), means the charge payable to the Government in respect of the ore or mineral excavated, consumed or removed from any land granted under these rules as specified in Schedule II.

2. Why levy of Royalties on Mineral Deposits?

Levy of Royalty on minerals is a universal concept based on the premise that mineral resources are “wasting assets”, “on-crop product” or “once only endowment”. Royalty levied on mineral production has been widely advocated for a number of reasons. The rationale for royalty is that it is a payment to mineral-rights holder from mineral producer in consideration for the extraction of valuable and non-renewable natural resources.

3. Mineral deposits and mining operations – legislative field:

Mining operations in India are regulated under the Mines and Minerals (Development and Regulation) [MMDR] Act, 1957, and has been, since then, amended from time to time.

The State Government, deriving powers from Entry 50 of List-II, are owners of minerals, grant mineral concessions and collect royalty, dead rent and fees as per the MMDR Act, 1957. These revenues are held in the Consolidated Fund of State Government until the State Legislature approves their use through budgetary processes. However, such power with the State is subject to powers of the Parliament. The power to levy such tax on mineral vests solely with the State Governments under Entry 50 of List – II (State List) and has not undergone any change because of GST. However, such power is subject to power of parliament to make law and regulate mines and minerals development under Entry 54 of the Union List. It is pertinent to note that Entry 50 of State List is specific than law making power of the parliament in Entry 54 in that matter of the Union List. Hence, Entry 50 will prevail being specific one in disputes arising in that matter. But here, the question as to authority to levy tax lying with the State which is an Executive Body, whereas it being a subject and authority of the Centre, is also contemplated.

The crucial locus of mining operations is that granting of mining rights over minerals are subject to royalty, dead rent (also known as seigniorage) and DMF charges. There is a subtle difference between the three though all of them are charges collected in relation to mining operations and a lucid understanding of the three is important.

A skim of the various definitions of ‘royalty’ concludes the understanding that it signifies the variable part of a reddendum depending upon the quantity of minerals excavated or the agreed payment to the patentee on every article made according to the patent. Rights or privileges for which remuneration is payable is in the form of a royalty.

In mining lease, lessee is conferred upon with the right not only to enjoy the property but also to extract the minerals from the land and to appropriate them for his own use or benefit, and so in addition to the usual rent for the death of the area, the lessee is also required to pay a certain amount in respect of the minerals extracted proportionate to the extracted quantity. Such payment is called ‘royalty’.

‘Dead rent’ is a fixed return paid to the lessor in order to ensure him a regular income, regardless of whether mine is worked properly or not, which if not worked properly would not yield enough return to the lessor in the shape of royalty.

Dead rent is calculated on the basis of the area leased while royalty is calculated on the quantity of minerals extracted or removed. So, it is determined in a way that while dead rent is a fixed return to the lessor, royalty is a return which varies with the quantity of minerals extracted and it is because of this reason that Section 9A of the MMDR Act, 1957 provides that the holder of mining lease is also required to pay either dead rent or royalty whichever is higher.

So, the above explanations based upon various definitions under the law, lucidly conclude that royalty is paid by a lessee to the lessor.

4. Tax on mining in India – a critical complication:

The mineral sector in India is the most taxed among all countries. The effective taxation rate on mining ranges between 60%-64%, eclipsing all other mining jurisdictions. It is pertinent to note that in India, the combined cascading effect of taxes on mining is very high compared to other resource-rich countries making India less competitive in global markets. Further, payment of royalties to the relevant governments is a common feature across the entire spectrum of mining leases in India, irrespective of the type of mineral.

The taxpayers in the field are encountering growing pains by Government furthermore levying taxes on royalty paid on mining operations.

Earlier, under the Service Tax Regime when Negative list-based taxation was introduced, only select services provided by the Government were out of Service Tax purview via Negative list and the rest were covered under Service Tax. Later, the list was amended to bring all the services provided by the Government under levy of tax. And these services were subjected to reverse charge requiring the recipient to pay tax. Since then, there has been a constant tussle between the tax authorities and the mining lease holders as to whether grant of mining lease by a government was a taxable service, thereby attracting Service Tax.

For long, this issue continued to bother the mining – trade/industry continuing into the GST regime as well because the statutory liability for payment of tax on such government services fell on the recipient of such services (i.e., the company receiving the mining lease) under Reverse Charge Mechanism. And most importantly, given the large amounts that are typically payable as royalty/dead rent, the GST exposure as well was expected to be very high.

5. Whether Royalty is a tax – an anatomy:

Before delving into the taxability of royalty paid on mining operations, the more imperative question here is whether royalty itself is in the nature of tax. This question fundamentally exerts influence on tax implications, which has been at stretch from a long time now as there cannot be levy of tax on tax which cannot be attached to the value of the goods/services. Although various judicial decisions to all intents and purposes explored the matter’s clear position in law, yet its tax implication still remains unclear with the taxpayers and the tax levying authority to say.

• India Cement Ltd. vs. State of Tamil Nadu:

In the leading case of India Cement vs. State of Tamil Nadu, the Hon’ble Supreme Court considered this issue whether royalty paid on mineral operations is a tax or not in order to examine authority of State to levy cess on royalty. The Supreme Court here had held the opinion that royalty is a tax and its payment is for the user of the land. The judgement had relied on a concept that royalty, in as much as some intrinsic economic value, is attributed to the extracted mineral created due to interaction among land, capital and labour, each of which possesses some definite intrinsic economic value. In this sense royalty was viewed as a kind of tax linked either directly or indirectly to the intrinsic economic value of a mineral realized through sale by the lessee. Explaining the view, the Court rightly positioned: – “Para 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.”

Although the intent and the missive were clear as set out in the judgement determining that royalty is a “tax” though not a “tax on land” as this was the question before them that whether Royalty is tax on land. However, the five-member bench in the case of State of West Bengal vs. Kesoram Industries Limited and Others yet doubted the judgement.

• State of West Bengal vs. Kesoram Industries Limited and Others:

In this case, whether cess can be levied by the State on coal, brick earth and minor minerals was an issue in consideration. A five-member bench of the Supreme Court was of the view that in the decision of India Cement, it was a typographical error in drafting the judgement either attributable to the stenographer’s devil or to sheer inadvertence.

However, the Court in the case of India Cement Ltd. actually meant to say that royalty was a tax. A thorough interpretation of the judgement rightly makes it clear that the professed typographical error was actually a reiteration of the varied discussions in the entire judgement. What the actual meaning and intent of the statement was that royalty was not a tax on land as it was not directly related to the land as required by Entry 49 but a different kind of tax that is to say, a tax on mineral extracted by individual which would be indirectly related to land.

Having doubted the seven-member bench decision in matter of India Cement Ltd., the five-member bench in Kesoram Industries Ltd. and Others, subsequently, to examine whether royalty is a tax or otherwise, referred the matter of Mineral Area Development Authority etc. vs. Union of India and Ors. to a nine-member bench of the Supreme Court.

The issues involved and the eventual outcome was worth noting as in the entire batch of matters, the questions as to constitutional significance centred w.r.t Entries 52, 54, and 97 of List I and Entries 23, 49 and 50 of List II of the Seventh Schedule to the Constitution of India as well as the extent and purpose of residuary power of legislation vested in the Union of India. Supreme Court held that royalty paid may not be tax under common parlance but going by the definition of ‘taxation’ under Article 366(28) of our Constitution, royalty payable on extraction of minerals being in the nature of statutory impost come under the purview of taxation.

Another significant matter Quarry Owner’s Association vs. State of Bihar and Ors. wherein it was opined that royalty may not be a tax in its usual sense but the question as to whether it will come within the purview of Clause 28 of Article 366 of the Constitution of India or not was not considered in any of the judgements.

The definition of the term ‘taxation’ under article 366(28) is of wide meaning and includes the imposition of any tax or impost, whether general or local or special, and tax shall be construed accordingly. In view of this wide definition given for the term ‘taxation’, the Supreme Court in the case of Kesoram Industries Limited even though doubted the findings of India Cement Limited that royalty is a tax in common parlance but concluded that it is a compulsory impost and is in the nature of tax considering the meaning of the word ‘taxation’ under article 366(28) of our Constitution.

6. Taxability under Service Tax:

While on the issue of applicability of Service Tax on Royalty in the erstwhile regime, a batch of petitions were filed before varied Courts across the Country wherein to mention a few, in the case of Udaipur Chamber of Commerce and Industry vs. Union of India (2018) the Court had held that Royalties paid on assignment of rights to use natural resources were a consideration and found no illegality on levy of Service Tax on Royalties. However, the Judgement was challenged before the Supreme Court which lastly stayed the payment of Service Tax on Royalties. The case – Goa Mining Association and Anr v Union of India and Ors (2017), is also worth noting where Bombay High Court had also stayed the imposition of service tax on royalties under section 9 of the Mines and Minerals (Regulation and Development) Act, 1957. A similar stay had come from Madras High Court too.

It is worth to note here that the Rajasthan High Court in the matter of Udaipur Chamber of Commerce and Industry had effectively held that Royalties are paid for assignment of right to use natural resources as consideration, therefore as per that judgment the service provided by the State Government is essentially that of providing “Right to Use” of natural resources if at all any service is provided. This should be kept in mind for the purpose of our discussion related to rate of tax under GST.

But examining applicability of levy, levy of tax under Service Tax was on provision of service. The term ‘service’ had been defined under section 65B(44) meaning any activity undertaken for consideration. As royalty is in the nature of compulsory impost being unilaterally decided by Government (not as price fixed under a contract between parties), it is in the nature of tax and thereby it did not come within the meaning of ‘service’ as defined to attract service tax. Hence, royalty already being in the nature of tax, further levy of service tax on the royalty paid towards mineral operations cannot be considered an activity for consideration to come under the ambit of service.

The Government is conferring mineral rights for payment of royalty by virtue of statutory duty conferred by law made by the parliament under the MMDR Act, 1957. Hence, granting of mineral rights is a sovereign and statutory function of the State. This position was already cleared by the Board in Circular No. 89/7/2006 dated 18.12.2006.

In that sense, it is clear that CBIC has already taken a view that the fee collected for performing sovereign and statutory functions cannot be considered as compulsory levy as per the provisions of relevant statute and deposited into Government Treasury. Such fee collected cannot be treated as consideration for a service.

7. Taxability under GST:

Now coming to the levy of GST under GST laws, it is on supply of goods or services. The term ‘supply’ is defined under section 7 of the CGST Act in an inclusive manner and it includes all activities undertaken for consideration unless expressly excluded under Schedule III. Going by the judicial decisions, royalty paid towards extraction of minerals is in the nature of tax and cannot be considered as consideration. However, we are looking at it here from the other perspective also assuming that there can be levy of GST on Royalty.

When GST was implemented, the classification of Royalty under GST was as such that Leasing Services were classified under Heading No. 9973 Leasing or Rental Services with or without Operator, where under this heading, Entry No. 997337 Licensing services for the right to use minerals including its exploration and evaluation was most suitable for Royalty as it is the only entry relating to extraction and use of minerals. As per this, the classification rightly fell into this Entry No. 997337.

The rate of tax on Royalty could be derived from the Notification No. 11/2017-Central Tax. As per this Notification the rate of tax for Heading 9973 were given in Entry No. 17, wherein there were 7 Sub-Entries to this Main Entry. Out of these 7 Entries, only 3 Entries had specific rates of 5%, 12 % and 18%. All the remaining Sub-Entries in this Entry carried rate of tax as “Same rate of central tax as applicable on supply of like goods involving transfer of title in goods”. The Heading No. 997337 did not qualify under any of the 3 Entries with specific rate. It only qualified for the residuary entry. Thus, the rate of tax on this entry of 997337 was that which was the rate of goods. Therefore, it was a conclusive understanding that the rate of tax on royalty shall be the rate which is applicable on the rate of goods i.e., minerals. Whatever is the rate of tax on minerals, the same rate was going to apply on Royalty.

However, Department brought various taxpayers into scrutiny who took and implemented such an interpretation and disputes followed. Divergent rulings were issued by Authorities for Advance Rulings (AAR) and Appellate Authorities for Advance Ruling (AAAR) on applicability of GST rate on the same. Where some ruled that the service of grant of mining leases is classifiable under Service Code 997337 and attracted the same rate of GST as applicable to minerals, whereas in certain other rulings a view had been taken that grant of rights for mineral exploration and mining would be covered under Heading 9991 and would attract GST @ 18%.

AAAR Odisha observed that GST rate applicable against Sl. No. 17 item (viii) of Notification No. 11/2017-Central Tax (Rate) prior to 01.01.2019 was not implementable. Unlike leasing or renting of goods, there are no underlying goods in case of leasing of mining area. The rate prescribed for goods cannot be made applicable to leasing of mining area, which confers the right to extract and appropriate minerals. The mining lease by Government, not being a lease of any goods, cannot attract the rate applicable to sale of like goods. Appellate Authority for Advance Ruling, Odisha had further held that the amendment carried out vide Notification No. 27/2018-Central Tax (Rate), dated 31.12.2018, which restricted the “same rate as applicable to supply of goods involving transfer of title in goods” only to leasing or renting of goods was to clarify the legislative intent as well as to resolve the unintended interpretation and that it is a settled law that interpretation which defeats the intention of legislature cannot be adopted. It accordingly upheld that “licensing services for the right to use minerals including its exploration and evaluation” falling under service code 997337 were taxable @ 18% during 01.07.2017 to 31.12.2018.

Taxpayers in this regard sought clarification as to the rate of GST applicable on supply of services by way of granting mineral exploration and mining rights during the period from 01.07.2017 to 31.12.2018 as w.e.f. 01.01.2019 the rate schedule had been specifically amended that such service attracted GST @ 18% from 01.01.2019 onwards. On 06.10.2021, a clarification was made that since the intent of the Council was always to tax this activity/supply @ 18% as a subject matter in all the previous meetings of the GST Council and that in the erstwhile regime as well, the Service Tax rate on such activity was 15.5%, so GST @ 18% shall apply. However, Hon’ble Supreme Court has imposed a stay on GST on royalty paid to the States for mining rights in the matter of Lakhwinder Singh.

8. Is there still any possibility of the rate of tax being the same as that on goods after the amendment dated 31.12.2018?

One can see that there is a possible interpretation based on the judgment of Rajasthan HC in the matter of Udaipur Chamber of Commerce and Industry (supra) wherein Hon’ble HC had held that:

“The royalty being “consideration” certainly places assignment of right to use natural resources deposited in the leased area as a “service” as defined under Section 65-B(44) of the Act of 1994, according to which, any activity carried out by a person for another for consideration is a service.”

The Hon’ble Court had considered Notification No. 25/2012 of the Service Tax in the judgment and discussed Entry 61 of the said notification inserted by Notification No. 22/2016 dated 13.04.2016, which read as follows: –

“61. Services provided by Government or a local authority by way of assignment of right to use any natural resource where such right to use was assigned by the Government or the local authority before the 1st April, 2016:

Provided that the exemption shall apply only to service tax payable on one time charge payable, in full upfront or in installments, for assignment of right to use such natural resource;”

The Board also issued a Circular No. 192/02/2016-Service Tax dated 13.04.2016 wherein it was clarified as under: –

The exemption shall apply only to Service Tax payable on one time charge, payable in full upfront or in installments, for assignment of right to use any natural resource and not to any periodic payment required to be made by the assignee, such as Spectrum User Charges, license fee in respect of spectrum, or monthly payments with respect to the coal extracted from the coal mine or royalty payable on extracted coal which shall be taxable.

Therefore, it is pretty clear from all of this that the Department sought to cover the Royalty under the service “Assignment of Right to use natural resources”. The same kind of entry is still there under Notification No. 11/2017-CT(Rate) after amendment dated 31.12.2018. The same is as follows: –

Comparing the interpretation under Service Tax with the entry of the current notification one can say that even after the amendment the rate of tax in case of Royalty shall be equal to same rate of Central Tax as on supply of like goods.

9. Validity of tax levy, ultimatum and way forward:

Relying upon the judicial decisions under the erstwhile regime of Service Tax, royalty cannot be termed as a consideration received by the Government to grant rights over the mine for mineral extraction. Further, it cannot also be said that State Government has supplied the service of granting rights for mineral extraction to come under the ambit of supply and thereby even under the existing regime, basis which no GST can be levied on royalty, dead rent and DMF charges paid towards mineral rights. On further perusal of above, and considering the decisions of the Apex Court that Royalty is in the nature of a compulsory impost and is a tax, an inference is drawn as such that levy of Service Tax in the erstwhile regime and now clarification of the Board with respect to levy of GST in GST regime is incorrect altogether and seems to be a masquerade.

Relying on the judgements and considering the definition of taxation contained in Clause 28 of Article 366 of the Constitution of India, it is a settled position of law that Royalty paid under a mining lease is in the nature of tax and thus, subsequently in various other matters coming up in the Courts, it can strongly be argued on the basis that GST could not be imposed on royalty since royalty itself is a tax and moreover, a tax cannot be in the nature of a payment for services rendered by the Government.

10. Can it be argued that the Royalty is a consideration against the transfer of title to goods?

As per Section 2(xliv) of the Rajasthan Minor Mineral Concession Rules, “Royalty” means the charge payable to the Government in respect of the ore or mineral excavated, consumed or removed from any land granted under these rules as specified in Schedule II.

Further, Section 9 of the Mines and Minerals Development and Regulation Act, 1957 also clearly stipulates that the holder of a mining lease notwithstanding anything contained in the instrument of lease or in any law in force is supposed to pay royalty in respect of any mineral removed or consumed by him or by his agent, manager, employee, contractor or sub-lessee from the leased area at the rate the time being specified in the second schedule in respect of that material.

Going by the plain reading of the text in the above explanations stated in the laws, it clearly positions royalty as a charge not on the service but upon the minerals or ores excavated from the land granted by the Government, which suggests that it is a charge against supply of goods and not services.

Further, although it was fundamentally argued in the matter of Udaipur Chamber of Commerce Vs. Union of India that grant of mining lease could not be brought within the definition of service as grant of mining lease is a transfer of right by the Government to lease holder to excavate the mineral by way of assignment, but it was so upheld by the Rajasthan High Court and opined that ‘An effort is also made to bring assignment under consideration in exclusion category with submission that by awarding lease the State transfers its title in goods in other manner than the sale or gift, as such, no service tax could have been claimed. This argument too, in our opinion, is bereft of merit as the term “goods” is defined under Section 65(50), assigning the same meaning as given under clause (7) of Section 2 of the Sale of Goods Act, 1930, according to that, it is every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be served before sale or under the contract of sale. The assignment of right to use any natural resource i.e., mineral cannot be treated as a goods for the purpose of the Act of 1994.’

However, the judgment does not discuss the definition of Royalty as per the provisions of MMDR Act, 1957, or Rajasthan Minor Mineral Concession Rules. Also, if at all it is stated that the Royalty is consideration against the supply of services, then how the title is transferred to the mining lease owner or the subsequent buyer and what is the consideration paid for the same? These questions remain unanswered. One can very well argue at all the times that though “Royalty” is named as such, it is actually the consideration against the supply of goods by which the title is transferred by the State to the mining lease holder and Rawanna is the document prepared for it. This argument then will ultimately lead that though Royalty is a consideration against supply of goods and the tax should have been payable on the same, still the tax in that case is not required to be paid under Reverse Charge Mechanism.

11. Concluding Remarks:

Royalty and tax on Royalty are very long pending matters in the judicial system of India which should be settled. The controversy started from the very beginning and continuing under GST as well.

The Supreme Court had imposed a stay on the stand taken by the Rajasthan High Court in the matter of Udaipur Chamber of Commerce Vs. Union of India in the erstwhile regime with respect to levy of Service Tax on Royalty paid on mining operations and now in the matter of Lakhwinder Singh Vs. Union of India with respect to levy of GST on Royalty paid on mining operations.

Rajasthan High Court as contradictory to its decision in the matter of Udaipur Chamber of Commerce Vs. Union of India, has recently granted a stay in the matter of Adapt Infra Pvt. Ltd. with respect to applicability of GST on royalty paid on mining operations.

On the basis of the above discussion, Assessees can clearly choose to litigate the levy of GST on royalty for grant of mining rights under mining leases and other comparable arrangements as the judicial review still remains pending.