Analysis of Recent Supreme Court Judgement dismissing petition of Union of India in case of RCM on Ocean Freight

[Brijesh Thakar]

Introduction

Supreme Court in its order UNION OF INDIA & ANR. VERSUS M/S MOHIT MINERALS PVT. LTD. THROUGH DIRECTOR - 2022 (5) TMI 968 - SUPREME COURT, dismissed a petition filed by the Union of India against the judgement of Gujarat high Court in case of M/s Mohit Minerals Pvt Ltd. In this article we will try to understand the issue and questions of law raised and decided by honourable Supreme Court. 

In the case of a CIF contract, the freight invoice is issued by the foreign shipping line to the foreign exporter, without the involvement of the importer. Ocean freight is paid by the importer only when goods are imported under an FOB contracts. Notification 10/2017 dated 28/06/2017, categorized the recipient of services of supply of goods by a person in a non-taxable territory by a vessel to include an importer under Section 2(26) of the Customs Act 1962 and provided that the importer is required to pay IGST on the freight amount even in case of CIF transactions.

A petition was filed by M/s Mohit Minerals Pvt Ltd under Article 226 for challenging the constitutionality of two notifications of the Central Government. The main question before the Gujarat High Court was whether an Indian importer can be subject to the levy of Integrated Goods and Services Tax on the component of ocean freight paid by the foreign seller to a foreign shipping line, on a reverse charge basis. The High Court allowed the petition and held that the notifications are ultra-vires to the GST law.

The Union of India filed an appeal against a judgment of Gujarat High Court.  

Issues before Gujarat High Court

A writ petition was filed before the Gujarat High Court challenging Notification 8/2017 and Notification 10/2017 on the grounds that: (i) the notifications are ultra vires the IGST Act and CGST Act (ii) customs duty is levied on the component of ocean freight and the levy of IGST on the freight element in the course of transportation would amount to double taxation (iii) though in the case of high sea sales, the importer is a different entity yet this regime would tax the respondent as the importer and the recipient of service (iv) in the case of a CIF contract, the supply of service of transport of goods in a vessel is by a foreign shipping line located in a non-taxable territory to an exporter located in a non- taxable territory by a vessel outside the territory of India which cannot be subject to tax under the IGST Act (v) Notification 10/2017 transgresses the provisions of Section 5(3) of the IGST Act as instead of the “recipient” mentioned therein, the “importer” as defined in section 2(26) of the Customs Act, is made liable to pay tax; and (vi) Entry 9(ii) and para 2 of Notification 8/2017, read with Notification 10/2017, creates a deeming fiction and a separate taxable event which is not permissible in law.

If we summarise the issues then we can say that once the freight portion is already included in the import value and the importer is paying IGST in the form of additional customs duty on the full value then how can he be again called upon to pay GST on the freight portion? Further, the importer is not paying anything to the transporter in case of CIF contracts. It is the exporter, who makes payment to the transporter. Hence, the recipient of service is exporter and not the importer. A separate taxable event has been attempted to be created by a delegated legislation ( notification) which is not envisaged by the parent legislation and consequently the delegated legislation is ultra-vires. 

Observations of Gujarat High Court

The view was accepted by honourable Gujarat High Court and the relevant entries of the RCM notification was stuck down by the Gujarat High Court.  The Gujarat High Court in its order stated as under- 

1.    The importer of goods on a CIF basis is not the recipient of the transport services as Section 2(93) of the CGST Act defines a recipient of services to mean someone who pays consideration for the service, which is the foreign exporter in this case
2.    Section 5(3) of the IGST Act enables the Government to stipulate categories of supply, not specify a third-party as a recipient of such supply
3.    There is no territorial nexus for taxation since the supply of service of transportation of goods is by a person in a non-taxable territory to another person in a non-taxable territory from a place outside India up to the Indian customs clearance station and this is neither an inter-state nor an intra-state supply
4.    Section 2(11) of the IGST Act defines “import of service” to mean the supply of service where the supplier of service is located outside India, the recipient of service is located in India and the place of supply of service is in India
5.    In this case, since the goods are transported on a CIF basis, the recipient of service is the foreign exporter who is outside India
6.    Section 7(5)(c) of the IGST Act dealing with intra-state supply cannot be read so extensively that it conflates the “supply of goods or services or both in the taxable territory” to “place of supply”
7.    Sections 12 and 13 of the IGST Act deal with determining the place of supply. Neither of them will apply if both the supplier and recipient of service are based outside India. The mere fact that the service terminates at India does not make the service of supply of transportation to be taking place in India
8.    The provisions regarding time of supply, as contemplated in Section 20 of the IGST Act and applicable to Section 13 of the IGST Act dealing with supply of services, are applicable only vis-à-vis the actual recipient of the supply of service, which is the foreign exporter in this case
9.    Section 15(1) of the CGST Act enables the determination of the value of the supply, only between the actual supplier and actual recipient of the service
10.     Since the importer is not the “recipient” of the service under Section 2(93) of the CGST Act, it will not be in a position to avail ITC under Section 16(1) of the CGST Act
11.    Since the importer pays customs duties on the goods which include the value of ocean freight, the impugned notifications impose double taxation through a delegated legislation, which is impermissible

Petition filed by Union of India against the order of Gujarat High Court

The petition filed by the Union of India against the order of Gujarat high Court stated mainly as under-
although tax is being paid twice on the value of ocean freight, it is not unconstitutional as the tax is on two different aspects of the transaction, namely, the supply of service and import of goods. The rationale for the impugned notifications, according to the Union Government, is to remove the disparity between Indian and foreign shipping lines, as the former are unable to claim input tax credit that forms a part of their transportation costs, since supply of goods was hitherto exempt from service tax. The purpose of the integrated tax is to introduce a level playing field between foreign shipping lines and Indian shipping lines. It is a settled principle that to tax one subject, the revenue does not have to tax everything . The levy of the integrated tax does not, according to the Union of India, impose an additional cost on importers as the cost paid on inward transportation of goods and import freight services is available to them as ITC.

The impugned notifications were issued after the GST Council took note of the fact that since transport of imported goods by Indian shipping lines to India is not treated as export of service, the Indian shipping lines pay IGST on the same on a forward charge basis. On the other hand, on the same transportation service, the foreign shipping lines are not required to pay tax as they are not taxable persons in India. Therefore, to provide a level playing field to Indian shipping lines, the importer in India has been made liable to pay IGST on transportation of goods by foreign shipping lines on a reverse charge basis. If Indian shipping lines continue to be taxed and not their competitors, namely, the foreign shipping lines, the margins arising out of taxation from GST would not create a level playing field and drive the Indian shipping lines out of business.

On reading of the contention of the Union of India we can understand that according to the opinion of the Union of India, there are two different aspects in the CIF contracts. One is provision of service and other is import of goods. And as there are two aspects of the transaction, we cannot call it a case of double taxation. Further, Union of India tried to justify the levy of tax on ocean freight in case of CIF transactions stating that it is to remove disparity between Indian and foreign shipping lines. Indian shipping lines were not able to take input tax credit as the supply of goods was exempt from service tax. Another argument made by the Union of India as stated above is that levy of tax on ocean freight shall not increase cost of the importer as he can anyway claim ITC of the tax paid. 

The elaborated submission by Union of India also discussed about the co-operative federalism and binding nature of  recommendations of GST council. Union of India stated that the spirit of the cooperative federalism must guide the functioning of the GST Council as envisaged in Article 279A(6). This was espoused by this Court in Union of India & Ors. Versus VKC Footsteps India Pvt Ltd. - 2021 (9) TMI 626 - Supreme Court where it was held that there is a need for a harmonised structure of goods and service tax. The GST Council is empowered to decide on every aspect of the GST law. The recommendations of the GST Council are binding on the executive and the legislature-while it frames laws relating to GST by the power under Article 246A. The constitutional scheme therefore envisages a two-step process. At the first level of the GST Council, Article 279A(6) envisages cooperative federalism and in the absence of either a non obstante clause in Article 279A or a ‘subject to’ clause in Article 246A, the need or requirement is that both the Union and the States should be supportive of this cooperative federalism through the process of collaborative federalism. 

In response to the issues raised regarding co-operative federalism and powers of GST Council, the respondents submitted that the GST Council which has been created by Article 279A of the Constitution is a recommendatory body, whose recommendations can be implemented by either amending the CGST Act or the IGST Act or by issuing a notification. However, notifications issued cannot be ultra vires the parent legislation. The principles of cooperative federalism are not relevant in this case as they were not adjudicated before the High Court. The appeal must test the correctness of the impugned judgment without expanding its scope. 

Main issues in the case and conclusions drawn by supreme court

1.    Binding nature of recommendations of GST council 

The issue of binding nature of the recommendations of GST council was raised by the Union of India because the GST council recommended in its meeting that the Indian Shipping lines and foreign shipping lines are on different footings.  As discussed above If Indian shipping lines continue to be taxed and not their competitors, namely, the foreign shipping lines, the margins arising out of taxation from GST would not create a level playing field and drive the Indian shipping lines out of business.

However, the court did not agree with the argument that the recommendations of the GST council is binding on parliament or state legislatures. As concluded by honourable Supreme Court, the Government while exercising its rule-making power under the provisions of the CGST Act and IGST Act is bound by the recommendations of the GST Council. However, that does not mean that all the recommendations of the GST Council made by virtue of the power Article 279A (4) are binding on the legislature’s power to enact primary legislations. Court after considering various earlier judgements and legislative history of GST law concluded that recommendations of the GST council are not binding and such compulsion shall be against the concept of even fiscal federalism. 

2.    Can importer be termed as “ recipient” in case of transport services in CIF contracts?

It is evident that the importer does not pay any consideration to the transporter and the transporter makes payment to the exporter in CIF contracts. The argument of the defendant that the importer cannot be called recipient of supply has been examined in detail by honourable Supreme Court. And surprisingly, disagreeing to the observation of Gujarat High Court, honourable Supreme Court held that the importer can be called recipient of transport service in CIF contracts. 

Section 5(3) of the IGST Act enables taxation of the recipients of certain specified categories of supply of services on a reverse charge basis. The term “recipient” of a supply of service has been exhaustively defined by Section 2(93) of the CGST Act. when no consideration is payable for the supply of a service, Section 2(93)(c) states that the recipient shall be the person to whom the service is rendered. Further, Section 2(93) provides that “any reference to a person to whom supply is made shall be construed as a reference to the recipient”. Hence, where the statute refers to a person to whom a supply is made, it has to be construed as a reference to the recipient of service. As noted by honourable Supreme Court, Section 13(9) of the IGST Act read together with Section 2(93)(c) of the CGST Act which defines a “recipient”. when the place of supply of services is deemed to be the destination of goods under Section 13(9) of the IGST Act, the supply of services would necessarily be “made” to the Indian importer, who would then be considered as a “recipient” under the definition of Section 2(93)(c) of the CGST Act. The supply can thus be construed as being “made” to the Indian importer who becomes the recipient under Section 2(93)(c) of the CGST Act.

Interestingly, the court rejected the argument of the respondent that if two recipients are identified for same supply then it will create the issue of availment of ITC by two persons. Court held that such an issue shall not arise in the present case as the foreign export is not paying tax and question of his availment of ITC shall not arise. The court also accepted the argument of Union of India that if not from section 5(3), then the government shall derive powers from section 5(4) of the IGST Act to define recipient. The Union Government has argued that Notifications 8/2017 and 10/2017 dated 28 June 2017 issued under Section 5(3) may also be read as issued under Section 5(4) of the IGST, in which case, the importers would be liable to tax with effect from 1 February 2019 though exempted for the period 13 October 2017 – 31 January 2019. Supreme Court held that It is settled law that non-reference of the source of power may not vitiate its exercise and application in given facts and circumstances of a case. In UNION OF INDIA AND ANOTHER Versus TULSIRAM PATEL AND OTHERS - 1985 (7) TMI 371 - Supreme Court, a Constitution Bench held that when a source of power legally exists, a non-reference or an incorrect reference during its exercise does not vitiate the action.

A mislabelling of the source of power would not vitiate its exercise (TITAGARH PAPER LIMITED ORISSA TEXTILES MILLS LIMITED Versus ORISSA STATE ELECTRICITY - 1975 (7) TMI 152 - Supreme Court). As long as a source of power to legislate or issue a notification is available, the lack of a mention, an incorrect reference or mistake does not vitiate the exercise of such power.

Hence as a conclusion court noted as under-

On a conjoint reading of Sections 2(11) and 13(9) of the IGST Act, read with Section 2(93) of the CGST Act, the import of goods by a CIF contract constitutes an “inter-state” supply which can be subject to IGST where the importer of such goods would be the recipient of shipping service.

3.    Power of parliament to tax extra-territorial transactions 

A Constitution Bench in GVK Industries  considered the question whether Parliament is competent to enact legislation with regard to extra-territorial aspects of certain events. The decision in GVK Industries clearly recognises the power of Parliament to legislate over events occurring extra-territorially. The only requirement imposed by the Court is that such an event must have a real connection to India.

It has been decided in GVK Industries case that It is important for us to state and hold here that the powers of legislation of Parliament with regard to all aspects or causes that are within the purview of its competence, including with respect to extra-territorial aspects or causes as delineated above, and as specified by the Constitution, or implied by its essential role in the constitutional scheme, ought not to be subjected to some a priori quantitative tests, such as “sufficiency” or “significance” or in any other manner requiring a predetermined degree of strength. All that would be required would be that the connection to India be real or expected to be real, and not illusory or fanciful.

Supreme Court agreed with the argument of Union of India that the parliament is well within its powers to impose tax on extra-territorial transactions if it has a real connection to India. And in case of the services supplied by foreign shipping line to foreign exporter there is a real connection to India as the goods are destined for India. 

4.    Composite Supply v/s Aspect Theory

The argument on this issue made by the Union of India was that the contract between importer and exporter is separate from the contract between exporter and foreign shipping line. One aspect of the transaction is that the exporter shall export the goods to Indian importer and the consideration for the same shall include cost, insurance and freight. The other aspect is the contract between the exporter and foreign shipping line. And as noted in point 3 above, the second aspect can be taxed in India even if it has extra- territorial aspect. 

As noted by court, 

the transaction at hand involves three parties- the foreign exporter, the Indian importer and the shipping line. The first leg of the transaction involves a CIF contract, wherein the foreign exporter sells the goods to the Indian importer and the cost of insurance and freight are the responsibility of the foreign exporter. In other words, the foreign exporter is liable to ensure that the goods reach their place of destination and the Indian importer pays the transaction value to the exporter. The second leg of the transaction involves an agreement between the foreign exporter and the shipping line (whether foreign or Indian) for providing services for transport of goods to the destination, i.e., in the territory of India.

On the first leg of the transaction, between the foreign exporter and the Indian importer, the latter is liable to pay IGST on the transaction value of goods under Section 5(1) of the IGST Act read with Section 3(7) and 3(8) of the Customs Tariff Act. Although this transaction involves the provision of services such as insurance and freight it falls under the ambit of ‘composite supply’. We note from the written submissions of the Union that the ASG has fairly submitted that this transaction would include value elements of freight and insurance, and yet the IGST is levied as a tax on supply of goods only. Such transactions are termed as “composite supply” under the CGST Act

It was argued by the respondent that applying aspect theory to this transaction and taxing the supply of service again shall be double taxation and it will be in violation of the concept of composite supply as defined under section 2(30) of the CGST Act. The argument of the Union of India was that in case of McDowell And Co. Limited Versus Commercial Tax Officer - 1985 (4) TMI 64 - Supreme Court it has been held that a single element can constitute the basis of a levy and can also form part of the value for another transaction. This cannot be termed as double taxation. Though court agreed that different aspects of a transaction can be taxed through separate provisions, it held that such kind of segregation in GST shall be in violation of concept of Composite Supply. The court noted that the idea of introducing ‘composite supply’ was to ensure that various elements of a transaction are not dissected and the levy is imposed on the bundle of supplies altogether. This finds specific mention in the illustration provided under Section 2(30) of CGST Act, where the principal supply is that of goods. Thus, the intent of the Parliament was that a transaction which includes different aspects of supply of goods or services and which are naturally bundled together, must be taxed as a composite supply. 

As a conclusion honourable Supreme Court noted that 

The impugned levy imposed on the ‘service’ aspect of the transaction is in violation of the principle of ‘composite supply’ enshrined under Section 2(30) read with Section 8 of the CGST Act. Since the Indian importer is liable to pay IGST on the ‘composite supply’, comprising of supply of goods and supply of services of transportation, insurance, etc. in a CIF contract, a separate levy on the Indian importer for the ‘supply of services’ by the shipping line would be in violation of Section 8 of the CGST Act.

 In this respect, Supreme Court agreed with the observation of Gujarat High Court that

The difficulty which is being experienced today in proper implementation of the GST is because of the erroneous misconception of law, or rather, erroneous assumption on the part of the delegated legislation that service tax is an independent levy as it was prior to the GST and it go vivisect the transaction of supply to levy more taxes on certain components completely overlooking or forgetting the basic concept of composite supply introduced in the GST legislation and the very idea of levying the GST

if such an erroneous impression is not corrected and if such a trend continues, then in future even the other components of supply of goods, such as, insurance, packaging, loading/unloading, labour, etc. may also be artificially vivisected by the delegated legislation to once again levy the GST on the supply on which the tax is already collected.

Supreme Court stated that a tax on the supply of a service, which has already been included by the legislation as a tax on the composite supply of goods, cannot be allowed. 

Author’s Note

Though the petition filed by the Union of India has been ultimately dismissed by the Supreme Court, many of the observations of Supreme Court in this case shall have far reaching impacts. A much debated issue of recommendatory powers of the GST council has also been concluded by the Supreme Court. This issue may decide the fate of the GST law in the days to come. The ratio decidendi and obiter dictum of this case are very significant for anyone having interest in Indian Taxation Laws. There are certain interpretations made by honourable Supreme Court which are not going well with some law experts. However as it is rightly said, “ Law means what the Judges interpret it to mean”.