Interpretation of Exemption Provisions in Indirect Taxes: Key Judicial Precedents

Vishwajeet Kumar Chaudhary 02 Jul 2024 66 Views 0 comment Print Goods and Services Tax | Articles

Interpretation of Exemption Provisions Under Indirect Taxes: Key Judicial Precedence and Implications

Introduction

Under the GST regime in India certain goods, services, and transactions are exempt immune to taxation. Understanding these exemptions can often feel like navigating a complex maze of legal jargon and regulations. In this excerpt the author delves into the intricate world of tax exemptions under Indian law, primarily focusing on the provisions within the Central Goods and Services Tax (CGST) Act and the Integrated Goods and Services Tax (IGST) Act. These Acts empower authorities to issue exemption notifications, potentially freeing entities from certain tax liabilities under specified conditions. Further, the Hon’ble Supreme Court has emphasised the need for a nuanced approach when interpreting exemption notifications in landmark cases which highlight the importance of strictly construing the language of exemptions while also considering the broader intent to prevent unjustly burdening taxpayers. By exploring key rulings and the principles of strict and liberal interpretation, the author sheds light on how taxpayers can navigate the challenges and opportunities presented by these exemptions.

Exemption under Tax Law

As per Section 11 (Power to grant Exemption) of the Central Goods and Service Tax (CGST) Act[1] and Section 6 (Power to grant exemption from tax) of the Integrated Goods and Service Tax (IGST) Act,[2] competent authorities are empowered to issue exemption notification upon the recommendation of the GST Council. The exemption can be either absolute or subject to conditions, as specified in the notification. Identical provisions can be found in Section 5A of Central Excise Act[3] in respect of excise duty and Section 25 (Power to grant exemption from duty) of the Customs Act[4] in respect of customs duty. The Hon’ble Supreme Court in the case of Union of India v Wood Papers Ltd[5] laid down the rules for assisting in construction of exemption notification as:

“Unlike charging provision, construction of exemption notification has to be tested on a different touchstone as the term ‘exemption’ may have varied meanings depending upon the context in which it is used. Literally, exemption is freedom from liability, tax or duty. Fiscally, it may assume varying shapes in the form of tax holiday to new units, concessional rate of tax to goods or persons for limited period or with the specific objective etc. Moreover, Liberal and strict construction of an exemption provision are to be invoked at different stages of interpreting it. In order to determine whether a subject fall within the parameters of the exemption notification then it being in nature of exception, strict interpretation rule is to be followed against the subject but once the ambiguity regarding applicability is lifted and subject falls in the notification then full play should be given to it and it calls for wider and liberal interpretation”.

Exemption notification should be interpreted strictly; the burden of proving applicability would be on the assessee to show that his case comes within the parameters of the exemption clause or exemption notification.

Analysis of the Dilip Kumar Case[6]

The dispute in this case arose as the respondent imported a shipment of Vitamin-E50 powder (feed grade) using Bill of Entry No. 8207, dated 19.08.1999 and further classified the imported product under Chapter 2309.90, which is commonly associated with prawn feed. Drawing reference from the Sun Export Corporation, Bombay v. Collector of Customs[7] (Sun Exports), the taxpayer filed an application to the revenue department requesting of a reduced duty rate of 5% instead of the standard 30%, as stated in Customs Notification No. 20/1999.[8] In the adjudication of the case, the commissioner of customs made a distinction between the case of Sun Exports and the present case. The Court upheld the contention of the revenue department to deny the concessional rate of duty. This was based on the ground that the imported goods contained chemical ingredients for animal feed, rather than being classified as animal feed/prawn as specified in Customs Notification No. 20/1999. Consequently, the claimed concessional rate of duty under the notification was not accepted.

On appeal by the taxpayer, the Commissioner of Customs reversed the order and noted that the Sun Exports ruling would be applicable in the case, the decision made by the Commissioner of Customs was further upheld by the Customs, Excise and Service Tax Appellate Tribunal (CESTAT). Furthermore, the appellate authorities and the High Court also upheld the taxpayer’s contention. Henceforth, aggrieved of the judgment of the CESTAT, the revenue department approached the Hon’ble Supreme Court where the designated division bench to hear the case reserved the ruling in Sun Exports. The matter was then presented before a three-judge bench of the Hon’ble Supreme Court, which suggested that the decision in the Sun Export case needs to be re-evaluated. The case was subsequently brought before a five-judge constitutional bench to address the issue of interpreting exemption clauses under tax law.

The issue before the Bench was to clarify the interpretative rule to be applied while interpreting tax exemption notifications in the course of any ambiguity that arose due to unsatisfactory state of law with reference to the entitlement of the rate of tax to be paid by the taxpayer.

Justice N.V. Ramana authored the judgement for the Bench invalidating the ratio given in the Sun Export case and clarified the controversy with regard to the interpretation of the ambiguous provision exempting tax.

The bench on Sun Export observed, “There cannot be any doubt that the ratio in Sun Export Case (supra) that, if two views are possible in interpreting the exemption notification, the one favourable to the assessee in the matter of taxation has to be preferred. This principle created confusion and resulted in unsatisfactory state of law. In spite of catena of judgments of this Court, which took the contra view, holding that an exemption notification must be strictly construed, and if a person claiming exemption does not fall strictly within the description of the notification otherwise then he cannot claim exemption”.^[9]

Principle Findings: After referring to a catena of previous judgements and considering the evolvement of legal landscape, the Hon’ble Supreme Court overruled the ratio of Sun Exports, the observation made by the bench are summed up herein below-

Exemption notification should be interpreted strictly; the burden of proving applicability would be on the assessee to show that his case comes within the parameters of the exemption clause or exemption notification.[10]
When there is ambiguity in exemption notification which is subject to strict interpretation, the benefit of such ambiguity cannot be claimed by the subject/assessee and it must be interpreted in favour of the Revenue.[11]
The ratio in Sun Export Corp case is not correct and all the decisions which took similar view as in Sun Export case stand overruled.[12]

Key Highlights: The judgement of the bench in the present case is of great importance as it settled the law in respect of exemption notifications. The ruling marked a distinction in interpreting a taxing provision (charging provision) and in the matter of interpretation of an exemption notification. It reiterated and concurred with the general principles of interpretation that when two views are principle, one favourable to the assessee in matters of taxation has to be preferred when interpreting the charging Section of the statute, but opposite principle would be applicable in interpretation of an exemption notification. Moreover, the taxation statutes were always subject to strict interpretation while the exemption notification were given quite liberal approach and in furtherance of this many assessee would rely on the ruling of Sun Exports and would comprehend the exemption provision liberally. This raises the concern of double standard and unlike interpretation of the exemption notifications while the present judgment counters this issue and provides guiding principles on interpretation of exemption notifications and erases the confusion associated with the interpretation.

Perspective of Strict Interpretation

In the case of Commissioner of Central Excise, New Delhi v. Hari Chand Shri Gopal[13] (Hari Chand) the Apex Court while answering to the issue of whether a person while claiming an exemption is required to comply with the procedure strictly to avail the benefits of exemption, introduced the ‘doctrine of substantial compliance’. This doctrine implies that the principle of strict construction cannot always be applied and is subject to exceptions based on where the provision is placed in the statute and the goal it aims to achieve. The doctrine asserts that if mandatory requirements are met, the enactment can be considered substantially complied with, even if there is non-compliance with directory requirements or mere technical provisions. In order to apply this principle, it is not enough to just make an attempt to comply. Actual compliance with the key elements is necessary. The doctrine allows for a remedy if a person has taken all reasonable steps but has minor faults that do not affect the essence of the requirement. Whether “substantial compliance” applies depends on the specific facts, the intended purpose, and the essential prerequisites of the rule.

In the wake of the Dilip Kumar case, the concept of substantial compliance is no longer an acceptable defence for bypassing the strict compliance requirement concerning exemption notifications that are dependent on meeting specific conditions. The court further quoted:

“Article 265 of the Constitution prohibits the State from extracting tax from the citizens without authority of law. It is axiomatic that taxation statute has to be interpreted strictly because State cannot at their whims and fancies burden the citizens without authority of law. In other words, when competent Legislature mandates taxing certain persons/certain objects in certain circumstances, it cannot be interpreted to include those, which were not intended by the Legislature.”

With this decision in mind, it is important for taxpayers to thoroughly assess if any exceptions, exemption clauses, or notifications apply to their situation in order to steer clear of possible legal disputes when seeking benefits as the burden of proving applicability would be on the assessee to show that his case comes within the parameters of the exemption clause or exemption notification.

Precedents and Current Judicial View

The Constitutional Bench constituted in the Dilip Kumar case for interpreting the nature of exemption notifications referred to a catena of early judgments and pronouncements of the Apex Court, some of its key rulings are as under:

Commissioner of Central Excise, New Delhi v. Hari Chand Shri Gopal: The Constitutional Bench, while ruling for the issue concerning the interpretation of exemption provisions to be substantive or procedural in character observed, “some of the provisions of an exemption notification may be directory in nature and some are mandatory in nature and it is essential that distinction between the provisions of a statute which are of substantive character and were built in with certain specific objectives of policy, on the one hand, and those which are merely procedural and technical in their nature, on the other, must be kept clearly distinguished”.[14] Furthermore, the bench also accepted the contention that in certain cases involving entitlement of exemption to the taxpayer, substantial compliance could be considered sufficient to grant exemption insofar as “doctrine of substantial compliance seeks to preserve the need to comply strictly with the conditions or requirements that are important to invoke a tax or duty exemption and to forgive non-compliance for either unimportant and tangential requirements or requirements that are so confusingly or incorrectly written that an earnest effort at compliance should be accepted”.[15]
Novopan India Ltd. v. Collector of Central Excise and Customs[16]: In this case, the Hon’ble Supreme Court ruled for the debate questioning the liability of burden of proof inasmuch as a claim of exemption is concerned. The Court observed that “person invoking an exception or an exemption provision to relieve him of the tax liability must establish clearly that he is covered by the said provision and in the case of doubt or ambiguity, benefit of it must go to the State”.[17]
Union of India v. Wood Papers Ltd[18]: In this case, a Division Bench of the Hon’ble Supreme Court observed that “the interpretation of exemption notification, unlike charging provision, has to be tested on different touchstone considering its varied meaning in different contexts. An exemption provision is like an exception and on normal principle interpretation of statutes, it is construed strictly because of legislative intention or on economic justification of inequitable burden or progressive approach of fiscal provisions intended to augment State revenue. But once its applicability is proved, it need not be construed strictly. Liberal and strict construction of an exemption provision is to be invoked at different stages of interpreting it. When the question is its applicability on the subject then it being in nature of exception is to be construed strictly and against the subject, but once ambiguity or doubt about applicability is lifted and the subject falls in the notification then full play should be given to it and it calls for a wider and liberal construction”.[19]
Mangalore Chemicals & Fertilizers Ltd. v. Dy. Commissioner of Commercial Taxes[20]: In this case, a Division Bench of the Hon’ble Supreme Court observed that “exemptions from taxation have the tendency to increase the burden on the other un-exempted class of taxpayers and should be construed against the subject in case of ambiguity”.[21]
CST v. Amara Raja Batteries Ltd[22]: The Hon’ble SC in Amara Raja case noted “an exemption notification should be given a literally (sic literal) meaning. Recourse to other principles canons of interpretation of statute should be resorted to only in the event the same give rise to anomaly or absurdity. The exemption notification must be construed having regard to the purpose and object it seeks to achieve”.[23]
Commissioner of Customs (Preventive) vs. M. Ambalal & Co^[24]: The Bench in this case observed that “It is settled law that the notification has to be read as a whole. If any of the conditions laid down in the notification is not fulfilled, the party is not entitled to the benefit of that notification. The rule regarding exemption is that exemptions should generally be strictly interpreted but beneficial exemptions having their purpose as encouragement or promotion of certain activities should be liberally interpreted”[25].

Drawing traces from the aforementioned cases it could be deduced that the Hon’ble Supreme Court had kept a mixed and distinct opinion prior to the ruling of Dilip Kumar case where the constitutional bench expressly mentioned that strict interpretation shall be followed in any case pertaining to the eligibility of exemption claimed by the assessee.

It was in the case of Government of Kerala v. Mother Superior Adoration Convent [26] (Mother Superior) where the Hon’ble Supreme Court acknowledged that the Constitutional Bench in Dilip Kumar case did not refer to the line of authority which made a distinction between exemption provisions generally and exemption provisions which have a beneficial purpose.[27] The Bench further observed, “the beneficial purpose of the exemption contained in Section 3(1)(b) must be given full effect to the line of authority being applicable to the facts of these cases being the line of authority which deals with beneficial exemptions as opposed to exemptions generally in tax statutes.”[28] Lastly the Bench concluded, “in similar cases, in order to clarify the steps required to be traversed a literal formalistic interpretation of the statute at hand is to be eschewed. We must first ask ourselves what is the object sought to be achieved by the provision, and construe the statute in accord with such object. And on the assumption that any ambiguity arises in such construction, such ambiguity must be in favour of that which is exempted”.[29]

Therefore, the ruling in Mother Superior introduced a new condition by emphasizing that the judgment in Dilip Kumar was restricted to a specific idea and does not cover all aspects of principles related to the interpretation of exemption provisions in tax law. The verdict further introduced a fresh perspective to the legal precedent set by Dilip Kumar and raises an additional point to consider before the true meaning of the exemption provision can be established.

Author’s Comment

The judgment given in Sun Exports was specific to notifications under the Customs Tariff Act and did not address the issue of interpreting the exemption provision in taxing statutes. After carefully examining the interpretation issues on the subject, the Apex Court has finally reaffirmed its previous stance and clarified the distinction between interpreting a charging provision in a tax statute and an exemption notification. The new ruling in Dilip Kumar lays precedence giving broader power to the tax administration to ensure that tax exemptions are granted only when strict eligibility criteria are met by the taxpayer. Further, if the ruling is applied retrospectively, the revenue department may seek backdated taxes from the previous cases awaiting assessment or adjudication. The responsibility of proving eligibility for a tax exemption will lie with the taxpayer to demonstrate to the Revenue Department that they qualify for it. If there is doubt when understanding a fiscal law and two interpretations are reasonably possible, the one that is more advantageous or favourable to the taxpayer should be chosen. If the income meets the requirements for two different exempting Sections, the taxpayer has the choice to be covered by both, unless specific provisions or necessary implications make them incompatible. Provisions concerning the assessment or collection of machinery should be interpreted in a way that makes it functional and achieves the intended purpose of the provisions. Interpretation of machinery provisions that renders the tax system ineffective and allows individuals to avoid taxation should be averted. Strict interpretation of penal provisions is necessary in the case of tax laws. If there is any uncertainty in the legislation, the taxpayer should be given the benefit of the doubt.

Conclusion

The complexity of exceptions in tax laws often ignites debates and discussions among scholars and tax professionals. Over time, various principles have emerged for interpreting exemption clauses, which are now widely accepted as the rules for fiscal exemption. The Hon’ble Supreme Court has made different decisions on this matter, resulting in multiple and sometimes conflicting propositions. This situation led to the establishment of a five-judge Constitutional Bench in the Dilip Kumar case to comprehensively address the issue. The Court ruled that exemption notifications should be strictly construed according to their wording. However, in the Mother Superior case, the Apex Court introduced a new condition, stating that if an exemption notification aims to encourage or promote certain activities, it should be interpreted liberally as a beneficial exemption. Lastly, the Revenue Department should grasp the legislative intent behind exemptions and not solely rely on the wording of the notification for strict interpretation.

[1] The Central Goods and Services Tax Act 2017, s 11

[2] The Integrated Goods and Services Tax Act 2017, s 6

[3] The Central Excise Act 1944, s 5A

[4] The Customs Act 1962, s 25

[5] Union of India v Wood Papers Ltd (1990) 4 SCC 256

[6] Commissioner of Customs (Import), Mumbai v Dilip Kumar and Company & Ors. Civil Appeal No. 3327 of 2007

[7] Sun Export Corporation, Bombay v Collector of Customs (1997) 6 SCC 564

[8] Customs Notification No. 20/1999.

[9] Dilip Kumar (n 5) 12

[10] Dilip Kumar (n 5) 16.1

[11] Dilip Kumar (n 5) 16.2

[12] Dilip Kumar (n 5) 16.3