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CASE NO.:

Appeal (civil) 3453 of 2002

PETITIONER:

Jindal Stainless Ltd. & Anr

RESPONDENT:

State of Haryana & Ors

DATE OF JUDGMENT: 13/04/2006

BENCH:

RUMA PAL B.N. SRIKRISHNA S.H. KAPADIA, TARUN CHATTERJEE & P.P. NAOLEKAR

JUDGMENT:

J U D G M E N T

KAPADIA, J.

WITH

CIVIL APPEAL NOs.3455, 3460, 3456-59, 3469, 3461,

3467, 3468, 3465, 3466, 3462-63, 3454, 3470 OF 2002;

8241, 8242, 8243, 8244, 8245, 8246, 8247, 8248, 8249,

8250, 8251 OF 2003; 5858 OF 2002; 8252 OF 2003;

3464 OF 2002; 3381-3400, 4651, 3592 OF 1998; 918

OF 1999; 4476 OF 2000; 2608 OF 2003; 4471 OF 2000;

3314 OF 2001; 5740 OF 2002; 6331, 2637 OF 2003;

6383-6421, 6436, 6437-40, 6422-35 OF 1997; 2769 OF

2000; 997-998 OF 2004; 3144, 3145, 3146, 4954, 5141,

5143, 5144, 5145, 5147, 5148, 5149, 5150, 5151, 5152,

5153, 5156, 5157, 5158, 5159, 5160, 5162, 5163, 5164,

5165, 5166, 5167, 5168, 5169, 5170, 7658 OF 2004;

SLP (C) NOs.10003, 10007, 10153, 10156, 10164,

10167, 10206, 10381, 10391, 10404, 10417,

10501,10563,10568,10571, 11012, 11271, 11326, 9496,

9569, 9883, 9891, 9898, 9904, 9910, 9911, 9976, 9993,

9998, 9999 OF 2004; 14380 OF 2005; TC NO.13 OF

2004, WP NOs.574 AND 512 OF 2003.

*****

By order dated 26.9.2003, the referring Bench

of Hon'ble Ruma Pal, J. and P. Venkatarama Reddy,

J. doubted the correctness of the view taken in M/s

Bhagatram Rajeevkumar v. Commissioner of

Sales Tax, M.P. & others relied on in the

subsequent decision of this Court in the case of

State of Bihar & Ors. v. Bihar Chamber of

Commerce & Ors. . Accordingly, all the matters

were ordered to be placed before the Hon'ble the

Chief Justice for appropriate directions and

accordingly, the matter has come to the

Constitution Bench to decide with certitude the

parameters of the judicially evolved concept of

"compensatory tax" vis-`-vis Article 301. The

referral order is in the case of Jindal Strips Ltd. &

Anr. (now known as Jindal Stainless Ltd.) v. State

of Haryana & Ors. under Article 145(3).

For this purpose, we are required to examine

the source from which the concept of compensatory

tax is judicially derived, the nature and character of

compensatory tax and its parameters in the context

of Article 301.

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In a batch of appeals, the constitutional

validity of the Haryana Local Area Development Tax

Act, 2000 has been challenged on two grounds : (1)

that, the Act is violative of Article 301 and is not

saved by Article 304; and (2) that, the Act in fact

seeks to levy sales tax on inter-State sales, which is

outside the competence of the State Legislature.

However, the referral order is confined to the above-

mentioned first question.

Jindal Strips Ltd. is an industry

manufacturing products within the State of

Haryana. The raw-material is purchased from

outside the State. The finished products are sent to

other States on consignment basis or stock transfer

basis. No sales tax is paid on the input of the raw

material. Similarly, no sales tax is paid on the

export of finished products.

The impugned Act came into force w.e.f. 5th

May, 2000 to provide for levy and collection of tax

on the entry of goods into the local areas of the

State for consumption or use therein. The Act is

enacted to provide for levy and collection of tax on

the entry into a local area of the State, of a motor

vehicle for use or sale, and of other goods for use or

consumption therein. The Act seeks to impose

entry tax on all goods brought into a "local area".

The entire State is divided into local areas. The Act

covers not only vehicles bringing goods into the

State but also vehicles carrying goods from one local

area to another. However, those who pay sales tax

to the State are exempt from payment of entry tax.

Ultimately, the entry tax only falls on concerns, like

Jindal Strips, which, by virtue of the provisions of

the Central Sales Tax Act, 1956, pay sales tax on

purchase of raw-material and sale of finished goods

to other States and do not pay sales tax to the State

of Haryana. This is the context in which the

challenge to the Act under Article 301 has been

made. At this stage, we may point out that prior to

September 30, 2003, section 22 stated that the tax

collected under the Act shall be distributed by the

State Government amongst the local bodies to be

utilized for the development of local areas.

However, on 30th September, 2003, section 22 was

amended clarifying that the tax levied and collected

shall be utilized for facilitating free flow of trade and

commerce.

REASONS FOR THE REFERRAL ORDER:

In Atiabari Tea Co. Ltd. etc. v. State of

Assam & Ors. , it was held that taxing laws are not

excluded from the operation of Article 301, which

means that tax laws can and do amount to

restrictions on the freedoms guaranteed to trade

under Part-XIII of the Constitution. However, the

prohibition of restrictions on free trade is not an

absolute one. Statutes restrictive of trade can avoid

invalidation if they comply with Article 304(a) or (b) .

In Automobile Transport (Rajasthan) Ltd. v.

State of Rajasthan , it was held that only such

taxes as directly and immediately restrict trade

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would fall within the purview of Article 301 and that

any restriction in the form of taxes imposed on the

carriage of goods or their movement by the State

Legislature can only be done after satisfying the

requirements of Article 304(b). The statute which

was challenged in Atiabari Tea Co.4 was the Assam

Taxation (on goods carried by Roads and Inland

Waterways) Act, 1954. It was held that the Act had

put a direct restriction on the freedom of trade and

since the State Legislature had not complied with

the provisions of Article 304(b), the Act was declared

void.

According to M/s Jindal Strips and similarly

situated other appellants, the impugned Haryana

Local Area Development Tax Act, 2000 imposes a

restriction on trade and is violative of Article 301,

particularly, when the provisions of Article 304(b)

have not been complied with.

The judgment of this Court in Atiabari Tea

Co.4 was delivered by a Constitution Bench of five

Judges. However, an exception to Article 301 and

its operation was judicially crafted in Automobile

Transport6. In that case, the challenge was to the

Rajasthan Motor Vehicles Taxation Act, 1951. The

challenge under Article 301 was rejected by the

Constitution Bench of seven Judges of this Court by

holding vide para 19 that "the taxes are

compensatory taxes which instead of hindering

trade, commerce and intercourse facilitate them by

providing roads and maintaining the roads". Vide

para 21 of the report, it was observed that "if a

statute fixes a charge for a convenience or service

provided by the State or an agency of the State, and

imposes it upon those who choose to avail

themselves of the service or convenience, the

freedom of trade and commerce may well be

considered unimpaired." Thus, the concept of

"compensatory taxes" was propounded. Therefore,

taxes which would otherwise interfere with the

unfettered freedom under Article 301 will be

protected from the vice of unconstitutionality if they

are compensatory.

In Automobile Transport6, it was said, vide

para 19, that "a working test for deciding whether a

tax is a compensatory or not is to enquire whether

the trade is having the use of certain facilities for

the better conduct of its business and paying not

patently much more than what is required for

providing the facilities".

Right from 1962 up to 1995, this working test

was applied by this Court in relation to motor

vehicles taxes for deciding whether the impugned

levy was compensatory or not. The decisions

proceeded on the principle adumbrated in

Automobile Transport6, which was paraphrased

by Mathew, J. speaking for a Bench of three Judges

in G.K. Krishnan & Ors. v. State of T.N. & Ors. ,

in which it was observed that "the very idea of a

compensatory tax is service more or less

commensurate with the tax levied". [See: para 29

page 386]

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According to the referral order, after 1995,

some of the principles set out stood deviated from

when the principle of compensatory tax was applied

to the entry tax in Bhagatram's case1, which was

decided by a Bench of three Judges.

In Bhagatram's case1, the challenge was to

M.P. Sthaniya Kshetra Me Mal Ke Pravesh Par Kar

Adhiniyam, 1976. In that case, although it was

demonstrated by the State and not disputed by the

assessee that the levy was compensatory,

nevertheless, the Court went on to say, vide para 8,

that "the concept of compensatory nature of tax has

been widened and if there is substantial or even

some link between the tax and the facilities

extended to dealers directly or indirectly the levy

cannot be impugned as invalid". In this connection,

reliance was placed on the judgment of this Court in

the case of State of Karnataka & Anr. v. M/s

Hansa Corporation . At this stage, it may be

noted that although there was a challenge to the

levy of entry tax in the case of Hansa

Corporation8, the issue whether the tax was

compensatory in nature was expressly left open,

particularly, because Article 304(b) stood complied

with. In fact, the impugned Act was saved because

Article 304 was complied with. It was for that

reason alone that the Act could not be struck down

in Hansa Corporation's case 8 .

The dictum in Bhagatram's case1 was relied

on by a Bench of two Judges in the case of Bihar

Chamber of Commerce2, which reiterated the

position that "some connection" between the tax

and the trading facilities extended to dealers directly

or indirectly is sufficient to characterize it as

compensatory tax. The Court went further to hold

that the State provides several facilities to the trade,

such as, laying and maintenance of roads,

waterways, markets etc. and on this premise, it was

held that the entry tax was compensatory in nature.

The learned Judges did not consider it necessary to

put the burden on the State to furnish the details of

facilities provided to the traders and the

expenditure incurred or incurrable thereafter.

To sum up: the pre-1995 decisions held that

an exaction to reimburse/recompense the State the

cost of an existing facility made available to the

traders or the cost of a specific facility planned to be

provided to the traders is compensatory tax and

that it is implicit in such a levy that it must, more

or less, be commensurate with the cost of the

service or facility. Those decisions emphasized that

the imposition of tax must be with the definite

purpose of meeting the expenses on account of

providing or adding to the trading facilities either

immediately or in future provided the quantum of

tax is based on a reasonable relation to the actual

or projected expenditure on the cost of the service

or facility. However, the post-1995 decisions in

Bhagatram's case1 and in the case of Bihar

Chamber of Commerce2, now say that even if the

purpose of imposition of the tax is not merely to

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confer a special advantage on the traders but to

benefit the public in general including the traders,

that levy can still be considered to be compensatory.

According to this view, an indirect or incidental

benefit to traders by reason of stepping up the

developmental activities in various local areas of the

State can be brought within the concept of

compensatory tax, the nexus between the tax

known as compensatory tax and the trading

facilities not being necessarily either direct or

specific.

According to the referral order, since the

concept of compensatory tax has been judicially

evolved as an exception to the provisions of Article

301 and as the parameters of this judicially evolved

concept are blurred, particularly, by reason of the

decisions in Bhagatram's case1 and Bihar

Chamber of Commerce2, the Court felt that the

interpretation of Article 301 vis-`-vis compensatory

tax should be authoritatively laid down with

certitude by the Constitution Bench under Article

145(3).

ARGUMENTS:

Mr. Shanti Bhushan, learned senior counsel

appearing on behalf of the Jindal Stainelss Ltd.

submitted that in Atiabari Tea Co.4 this court held

that even a tax legislation would have to bear the

scrutiny of Part-XIII of the Constitution and such

legislation could infringe Article 301 to 304 of the

Constitution; that the tax laws were within the

ambit of Part-XIII of the Constitution; that seven-

Judge Constitution Bench of this court in

Automobile Transport6 for the first time judicially

evolved the principle of compensatory taxes which

would be outside the purview of Part-XIII and which

could not be said to impede free flow of trade and

commerce [majority view]. Such compensatory

taxes were no hindrance to freedom of trade so long

as they remained reasonable. Such compensatory

taxes, in essence and reality, facilitated trade and

commerce and they were not restrictions, it was

held that the substance of the matter has to be

determined in each case. Learned counsel placed

reliance on the judgment of Justice Das from pages

522 to 523, in this regard. Learned counsel

submitted that the working test laid down in the

Automobile Transport6 is good even today. Under

the test, although the precise amount collected may

not be actually used to provide any facility, the tax

collected should be by and large commensurate

with the cost of the facilities provided for the trade.

Learned counsel, therefore, submitted that the

working test laid down in Automobile Transport6

is the only test which would differentiate the tax

imposed for augmenting general revenue from the

compensatory tax. Learned counsel submitted that

there is a basic difference between the law infringing

freedom of trade and the law which imposes

regulations which in effect facilitates or promotes

trade. According to the learned counsel, regulations

provide for necessary services to enable free

movement of traffic and, therefore, they cannot be

described as restrictions impeding the freedom

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under Article 301; that in the case of regulations the

tax imposed is incidental in order to compensate for

the facilities provided. On the other hand, it was

urged, that, a tax law is in essence an exercise to

augment the general revenue of the State and not

for providing facilities and services for the trade. A

tax law which does not in return provide services

and facilities for the free movement of trade, can

never be compensatory. Learned counsel further

submitted that in Bhagatram's case1 vide para 8,

the Division Bench of this court held that \026 "the

concept of compensatory nature of tax has been

widened and if there is substantial or even some

link between the tax and the facilities extended to

such dealers directly or indirectly the levy cannot be

impugned as invalid". In that case the Division

Bench of this court relied upon the judgment of this

court in the case of Hansa Corporation8. Mr.

Shanti Bhushan, learned counsel for the assessees,

submitted that the judgment of this court in the

case of Bhagatram1 was erroneous on two counts.

Firstly, the reliance on Hansa Corporation8 was

totally misplaced because Hansa Corporation8 did

not deal with the issue of what is compensatory tax.

In fact, that question was expressly not gone into.

Secondly, learned counsel submitted that to the

extent of Bhagatram1 holding that the concept of

compensatory tax has been widened as stated

above, the said judgment was contrary to the law

laid down by the seven-Judge Bench decision of this

court in the case of Automobile Transport6 and,

therefore, needs to be overruled. Mr. Shanti

Bhushan further contended that the Division Bench

of this court in the case of Bihar Chamber of

Commerce2 has followed the judgment of this court

in the case of Bhagatram1 and has held that even

though the tax was for augmenting the general

revenue of the State, judicial notice could be taken

of the fact that the State provides several facilities to

the trade including laying and maintenance of

roads, waterways, markets etc. and on that basis it

was held that the State had established the

impugned tax to be compensatory in nature. In

short, Mr. Shanti Bhushan's submission was that

the aforestated two judgments in Bhagatram1 and

in Bihar Chamber of Commerce2 were erroneous

to the extent indicated above; that they were

contrary to the judgment of seven-Judge Bench of

this court in the case of Automobile Transport8.

Learned counsel urged that if the test, laid down in

the case of Bhagatram1 and in the case of Bihar

Chamber of Commerce2, was held to be applicable

then as a consequence there would be no difference

between a tax and a compensatory tax. It was

urged that therefore this court should evolve

parameters of compensatory tax for future

guidance. Learned counsel submitted that to be

compensatory, tax must be levied to augment

facilities for trade and that is how a tax was held

not to impede but to facilitate trade (in Automobile

Transport6). It was submitted that the essence of

compensatory tax is that the services rendered or

facilities provided should be more or less

commensurate with the tax levied and the tax

should not be patently more than what was

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required to provide the trading facility. It was

submitted that the tax imposed for augmenting

general revenue of the State is not compensatory;

that any tax law which is designed or which has the

effect of disrupting trade movement in inter-State

trade and commerce between States is contrary to

the concept of freedom of trade embodied in Article

301. It was submitted that the compensatory

character of tax should be self-evident from the

taxing law itself and it cannot be judged from the

manner in which the tax revenue is utilized in

course of time. It was urged that in the case of

ambiguity, the burden would fall on the State to

show that in essence the levy was imposed as a

recompense for the facilities/services provided by

the State. It was urged that in the case of Sanjay

Trading Company v. Commissioner of Sales Tax

and others , the tax was held to be compensatory

based on the figures furnished by the State and it

was found that the levy was imposed to offset the

loss caused by the abolition of octroi which

according to the learned counsel is totally missing

in the case of Haryana Local Area Development Tax

Act, 2000.

Mr. A.K. Ganguli, learned senior counsel

appearing on behalf of one of the appellants,

submitted that the legislative power of the State to

make any law under Article 246 read with the

entries in list II, though plenary in nature, is

subject to two limitations:

(i) Fundamental Rights

[Part III of the Constitution)

(ii) Trade, Commerce and Intercourse

within the Territory of India

(Part XIII of the Constitution)

Therefore, the State cannot exercise its legislative

power in a manner which would transgress the

above constitutional limitations. In this connection,

learned counsel placed reliance on the judgment in

Atiabari Tea Co.4. Learned counsel further urged

that keeping in mind the impact of globalization

since mid-1990s the international trade barriers

stand removed in view of multi-lateral trade

agreements between the committee of nations. He

submitted that the framers of the Constitution

engrafted Part-XIII in the Constitution with the

object of securing economic unity of the country as

a whole and, therefore, the State's power of

imposing taxes and duties on goods, freedom of

which throughout India is guaranteed by Article

301, would be subject to the said limitation.

Learned counsel urged that taxing statutes

imposing duties on goods do attract Article 301;

that the intrinsic evidence furnished by the Articles

in Part-XIII shows that the taxing laws are not

excluded from the operation of Article 301; which

means that tax laws do amount to restrictions,

freedom from which is guaranteed to trade under

Part-XIII. It is, therefore, idle to contend as sought

to be argued on behalf of the State that a tax under

entry 52 list II falls outside Article 301. Learned

counsel submitted further that in Atiabari Tea

Co.4 a workable test has been evolved under which

restrictions which directly and immediately impede

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free flow of trade, would violate Article 301.

According to learned counsel one needs to enquire

whether the trade is provided with facilities for the

better conduct of their business. According to

learned counsel once the said working test is

satisfied then the levy is regulatory in nature

provided it is not disproportionate to the value of

the facility/service provided. Learned counsel urged

that a tax imposed for raising general revenue of the

State is not a compensatory levy. It was submitted

that for the purpose of securing freedom of

movement by road, it was essential that no

pecuniary burden is placed upon it which burden

goes beyond a proper recompense to the State for

the actual use made of the facilities provided by the

State. Therefore, there has to be a direct relation

between the levy and the facility and the users must

derive a special direct benefit of that facility. It

was submitted that Part-XIII imposes constitutional

limitations on the legislative powers of the State, the

onus would lie on the State to demonstrate that the

provisions of the impugned enactment facilitate the

free flow of trade by providing a regulatory measure.

Similarly, in respect of taxing statutes, the burden

would lie heavily on the State administration that

the taxes proposed to be levied and collected under

the impugned enactment are for the use of trading

facilities and only then that such levy would come

within the purview of compensatory tax as laid

down in the judgment of this court in the case of

Automobile Transport6. According to the learned

counsel mere declaration in law that the levy is

compensatory in nature is not enough. Whether a

tax is compensatory or not, cannot depend on the

preamble of the statute imposing it. A tax cannot

be said not to be compensatory merely because the

precise or specific amount collected is not actually

used to provide facilities. In this connection,

reliance is placed on the judgment of this court in

the case of Sharma Transport v. Government of

Andhra Pradesh & Ors. . However, learned

counsel submitted that the Act must spell out the

nature of the trading facilities intended to be

provided to the trading community and also the cost

of providing such facilities. Learned counsel

submitted that the Act must indicate a direct co-

relation between the two.

At this stage, we may clarify that we are not

required to go into the question as to whether the

impugned tax based on ad valorem basis cannot be

termed as a compensatory tax. As stated above, we

are confining this judgment only to the question as

to whether the observations of this court in the case

of Bhagatram1 (supra) followed by the judgment of

this court in the case of Bihar Chamber of

Commerce2 needs to be overruled in the light of the

judgment of seven-Judge Constitution Bench in the

case of Automobile Transport6. In the present

matter, we are required to lay down the parameters

of the concept of compensatory tax vis-`-vis Article

301. All other questions will have to be gone into at

the relevant stage before the division bench of this

court with regard to the constitutional validity of

2000 Act.

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Learned counsel next submitted that the

question as to whether a levy is compensatory or

not has to be decided with reference to the nature of

the levy itself. In this connection reliance was

placed on entry 57 List II. It was urged that taxes

on motor vehicles are levied statewise. Such levies

are annual levies. Such levy, if claimed to be

compensatory, must bear a definite nexus with the

facilities which the State seeks to extend to the

trading community using their transports on the

roads and bridges maintained by the State.

Similarly, it was argued that levy of entry tax under

entry 52 list II indicates that the levy contemplated

is on the entry of goods into a local area for

consumption, use or sale therein. It was submitted

that the levy contemplated is on entry into a local

area and not when the goods cross the State

barrier. Therefore, if a levy of entry tax is claimed to

be compensatory in nature such levy would have to

be, in the first instance, confined to a local area and

secondly the trading facilities sought to be provided

also should be confined to such local area. Further

the expenses for such facilities and the levy by

which such expenses are to be met must bear a

reasonable and rational relationship.

Mr. R.F. Nariman, learned senior counsel

appearing for one of the appellants, submitted that

the ingredients of a compensatory tax broadly fall

into two categories, namely, positive ingredients

which ought to be there to constitute a

compensatory tax and negative ingredients which if

present, the tax in question cannot be called a

compensatory tax. In this connection, learned

counsel submitted that if the purpose of levy is to

raise resources for above-stated facilities or if the

resources are raised as regulatory measures to

facilitate trade then such an ingredient is a positive

ingredient. Similarly, the quantum of such

compensatory tax must co-relate with the funds

required for such facilities/regulatory measures.

According to learned counsel these are two positive

ingredients. The negative ingredients, which if

present, would make the tax labelled as

compensatory, attract the vice of interference with

freedom of trade, are two-fold - firstly, if the tax is

for general augmentation of revenue, and secondly,

the said compensatory tax must not be

discriminatory. According to learned counsel, the

purported compensatory tax must also not be for

trade facilities and purposes for which there is

already a levy of other compensatory tax. Learned

counsel next urged that in the case of Bhagatram1

a three-Judge bench of this court noted that "the

levy was in fact demonstrated to be compensatory"

and, therefore, the latter observation by the court

saying that "the concept of compensatory nature of

tax has been widened and if there is some link

between the tax and the facility the levy cannot be

impugned as invalid" is obiter dicta and such

observation is not supported by any of the

previously decided cases. It was urged that under

2000 Act the entry tax lacks the positive ingredients

enumerated above for a valid compensatory tax. As

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there is no facility even mentioned with relation to

entry of goods into local area for use, consumption

or sale and, therefore, the link between local area

and levy is absent and consequently collection of

levy not by the local authority but by the State on

entry of goods from outside State is

unconstitutional. Further, according to the learned

counsel, negative ingredients indicated above also

exist in the impugned levy inasmuch as the

justification pleaded is augmentation of general

revenue of State in lieu of octroi in name of facilities

for which provisions are made by way of other

compensatory taxes such as motor vehicle tax,

property tax etc. Learned counsel submitted that

there is also an element of discrimination between

goods entering local areas from outside State and

goods entering local area from within the State, i.e.,

from one local area to another local area. The latter

class of goods are not subjected to levy though all

the facilities, if at all provided, are there in course of

intra-State movement and entry of goods in local

areas. Learned counsel, therefore, submitted that

this discrimination per se militates against the

impugned levy being termed as compensatory.

S/Shri A.M. Singhvi, learned senior counsel,

A.T.M. Sampath, H.K. Puri and Ms. K.S. Mehlwal

also made their respective submissions on behalf of

the assessees and substantially adopted the

submissions made by S/Shri Shanti Bhushan, R.F.

Nariman and A.K. Ganguli, learned senior counsel.

Shri P.P. Rao, learned senior counsel

appearing on behalf of the State of Haryana,

submitted that the impugned 2000 Act does not

suffer from want of levy competence; that the State

legislature has the competence under entry 52 list II

to enact the impugned law; that the State

legislature is competent to levy such tax because

the incidence of tax is on the entry of goods into a

local area for consumption, use or sale therein and,

therefore, it is not a tax on the import of goods from

outside India, nor a tax on the manufacture of

goods, nor a tax on the export of the goods to places

outside the State. Finally, it is not a sales tax.

Learned counsel further contended that under entry

52 list II it is not obligatory for the State to enact a

law for the levy of entry tax on goods which are

brought for use, consumption or sale; it is within

the power of the State to make a law for levy of such

tax on goods brought for use, consumption or sale.

Learned counsel submitted that the legislature has

selected goods brought for use or consumption in a

local area for the purposes of the levy; that it is

within the power of the State to make a law for levy

of tax on goods for any of the three purposes or for

one of them or two of them. Learned counsel

submitted that Article 286 read with entry 41, entry

83, entry 92A and entry 92B does not have any

bearing on the constitutional validity of the

impugned 2000 Act because the above entries deal

with different subjects; that the entry tax is not a

tax on sale of goods affected by branch transfer or

export out-of-State. Learned counsel urged that the

entry tax is compensatory in character and,

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therefore, the impugned levy which is compensatory

in nature, as can be seen from section 22 of the

said Act, does not attract Article 301 and Article

304(a) of the Constitution. Learned counsel

submitted that section 22 of the Act was amended

on September 30, 2003 clarifying that the tax levied

and collected shall be utilized for facilitating free

flow of trade and commerce. Learned counsel,

therefore, submitted that the levy is compensatory

in nature. Learned counsel next contended that

the compensatory levy need not satisfy the rule of

quid pro quo strictly; that it is sufficient that there is

some relation or nexus between facilities provided

and the tax imposed. Even the concept of fee has

undergone significant change over the years as a

result of a catena of decisions of this court and,

therefore, this reference under Article 145(3) of the

Constitution was uncalled for. As a matter of

preliminary submission, Shri P.P. Rao, learned

senior counsel for the State, contended that in view

of the amendment made by Act 18 of 2003 adding

an explanation to section 22 of the impugned 2000

Act clarifying that the tax collected shall be utilized

for developing and maintaining infrastructure

facilities useful for free flow of trade, the question

involved in this matter has become academic.

Learned counsel submitted that in view of various

decisions of the Constitution Bench the case should

have been first placed before a bench of three

Judges and not before a constitution bench straight

away. It is only when that bench refers it to five

Judges that the case should have been placed

before a constitution bench because it has been a

settled law that a bench of two judges is bound by

the principles of law laid down by a bench of three

judges which alone has the jurisdiction to interpret

the law declared by a constitution bench. In this

connection reliance was placed on two judgments of

this court, in the case of Pradip Chandra Parija &

Ors. v. Pramod Chandra Patnaik & Ors. and in

the case of Central Board of Dawoodi Bohra

Community & Anr. v. State of Maharashtra &

Anr. . On merits learned counsel urged that the

Constitution contemplates levy of taxes and levy of

fees. He urged that in the case of fees, quid pro quo

is an essential element though not in taxes.

However, compensatory taxes are an exception;

they contain an element of quid pro quo but not to

the extent as in the case of "fees". Learned counsel

placed reliance in this connection on the judgment

of this court in the case of M/s International

Tourist Corporation etc. etc. v. State of

Haryana and others etc. etc. . Learned counsel

submitted that the extent of quid pro quo required

in a fee has undergone a sea-change and it would

be irrational to insist on such a test in the case of

compensatory tax. Learned counsel next submitted

that the element of compensation in compensatory

taxes needs to be interpreted taking note of

constitutional developments, the changed

perception of the entire relationship of fundamental

rights and directive principles as well as the sea-

change in the concept of fee particularly with

reference to the element of quid pro quo. Learned

counsel submitted that the principles of law

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declared in Bhagatram1 are consistent with

contemporary thinking about the basic concepts of

tax, fee and compensatory tax with due regard to

the developments subsequent to Automobile

Transport6.

Shri Rakesh Dwivedi, learned senior counsel

appearing for the State of U.P., submitted that while

laying down parameters of compensatory tax for

purposes of Part-XIII it is necessary to note that

under the scheme of our Constitution, States have

certain powers including the power to raise revenue

by taxation and further Article 301 has to be

applied for the working of an orderly society.

Learned counsel submitted that the States must

have revenue to carry out their administration; that

there are several items relating to the imposition of

taxes in list II, therefore, according to learned

counsel the Constitution framers intended that

under such items the States are entitled to raise

revenue for their own purposes. Learned counsel

submitted that any wide view of the word "freedom"

under Article 301 or even a restricted view of the

term "compensatory tax" would put an end to the

State autonomy and its plenary powers within the

fields allotted to them. In this connection reliance

was placed on the judgment of this court in the

case of Automobile Transport6. It was urged that

the State legislature may impose different kinds of

taxes and duties such as property tax, sales tax,

excise duty etc. and legislation in respect of any one

of these items, may have an indirect effect on trade

and commerce. Learned counsel submitted that if

every law made by the State legislature which has

an indirect effect on free flow of trade is required to

have prior sanction of the President then the

Constitution insofar as it gives plenary power to the

States and the State legislatures in the fields

allocated to them would be rendered meaningless

and, therefore, it cannot be laid down as a general

proposition that the power to tax is outside the

purview of constitutional limitation of Part-XIII.

Learned counsel submitted that in any event

regulatory measures and compensatory taxes are

not hit by Article 301. Learned counsel urged that

in every case the court will have to ascertain

whether an impugned law directly and immediately

affects the movement of trade or whether it

indirectly or remotely affects such movement.

Learned counsel submitted that while Parliament

cannot trench upon the exclusive domain preserved

for the State legislature under list II, the central

executive nevertheless would oversee and sanction

most of the taxing measures under Article 304 and,

therefore, the wider concept of compensatory tax

should be accepted. Learned counsel next

submitted that all taxing power is for raising

revenue. However, it cannot be argued that while

imposing a compensatory tax the States cannot

raise general revenue. Learned counsel submitted

that this court has drawn consistently a distinction

between a "tax" and a "fee", and the power of

taxation has always been understood as a power to

raise revenue. It was urged that even in

Automobile Transport6, while discussing the

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concept of compensatory tax, this court never

intended to lay down that such compensatory taxes

are not revenue measures but are fees. Any such

view would be contrary to the scheme of

distribution of powers and also the structure of the

seventh schedule and, therefore, a tax which is

levied to facilitate trade and commerce would

remain compensatory even if some extra revenue is

generated. Learned counsel next submitted that

even with respect to fee for licence and fee for

service this court has adopted a broad test of co-

relation between money raised and expenditure

incurred; in this connection reliance, was placed on

the judgment of this court in the case of Ram

Chandra Kailash Kumar & Co. & Ors. v. State

of U.P. & Anr. . In the above case it was held that

the amount of fee realized must be earmarked for

rendering services to the licensees in the notified

market and a substantial portion of it must be

shown to be spent for the requisite purpose. That

the services rendered to the licensees must be in

relation to the transaction of purchase or sale of the

goods; that while rendering services in the market

area for the purposes of facilitating the transactions

of produce and sale, it is not necessary to confer the

whole of the benefit on the licensee but some

special benefit must be conferred on the licensee

which must have a direct, close and reasonable co-

relation between the transaction and the licensee.

That the spending of the amount of market fees for

augmenting agriculture produce, for augmenting

the facility of transport in villages with a view that

such services in the long run would increase the

volume of transactions in the market, was not

permissible on the ground that such a benefit was

an indirect and remote benefit to the traders; that

the element of quid pro quo may not be possible but

even broadly and reasonably, it must be established

by the authorities who charge the fees that the

amount was being spent for rendering services to

traders on whom the burden falls. Learned counsel

submitted that the tests laid down with regard to

quid pro quo under principles 2, 3 and 5 in the case

of Ram Chandra Kailash Kumar14 have no

application to the compensatory tax because the

concept of compensatory tax is only to judge the

effect on trade, commerce and intercourse and,

therefore, according to learned counsel the test of

direct and close relation/link between the levy and

the service rendered, cannot be applied to the

concept of compensatory tax. Learned counsel

submitted that the only test which is applicable to

the concept of compensatory tax is \026 whether "trade

and commerce" is benefitted generally by such levy;

that, it should be sufficient if the facilities provided

in the local area ultimately lead to better trading

and commerce and even indirect benefit to traders

in future on the ground that such services would

increase the volume of trade in the market, can

constitute an important element of compensatory

tax. Learned counsel next urged that the

parameters for adjudging a tax as compensatory or

regulatory would depend upon the nature of tax or

in other words, the particular entry in list II with

respect to which the tax is imposed. In this

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connection, it was urged that the scope of entry 52,

entry 56, entry 57 and entry 59 in list II cannot be

identical and, therefore, the parameters for those

entries cannot be identical, they have to be

different. That, the very nature of tax indicates the

nature of facility with which the tax has a link.

While entries 56, 57 and 59 indicate a nexus with

road, waterways, bridges etc. entry tax under entry

52 does not have such limited range of facility. It

has a nexus with local area which is equivalent to

local authority as held in the case of Diamond

Sugar Mills Ltd. & another v. The State of U.P.

& Anr. . According to learned counsel entry tax,

therefore, is for the purposes of enabling the local

bodies to discharge their several functions. Learned

counsel next urged that there is one more aspect of

entry tax, it has a co-relation to bring in goods for

consumption, use or sale in a local area. The

consumption, use or sale not only require roads but

also a proper hygiene, lighting, drinking water,

health, sanitation etc.; that, it is not possible to

have trade without such facilities, therefore, the

compensatory character of the entry tax has to be

adjudged with reference to the revenue collected

and with reference to the various functions of the

local body. Learned counsel contended that a tax

can also be collected by the State and then assigned

to the local body; that such collection avoids

duplication of levy. Learned counsel contended that

uneven economic development of various States in

India hampers and hinders free flow of trade

throughout India and, therefore, it is in the interest

of trade and commerce that backward areas should

be developed and, therefore, merely because the

States assigned proportionately more money to

backward local areas should not be objected to, so

long as good and substantial portion assigned to

the specified local area from which tax is collected.

Learned counsel, therefore, contended in conclusion

that a broad co-relation of the levy with the facility

was enough. Learned counsel contended that in

the case of Bolani Ores Ltd. etc. v. State of

Orissa etc. , the Taxation Act envisaged

imposition of tax on motor vehicles actually using

the roads saying that if the facility is not used then

no tax can be collected and if collected it will not be

compensatory. Learned counsel contended,

however, that the judgment of this court in Bolani

Ores16 was in the context of entry 52 list II which

restricts the imposition of tax by actual use of roads

by vehicles. A tax upon vehicles need not be

contingent upon actual user. In this connection

reliance was placed on entry 57. Therefore, it was

submitted that a compensatory character of tax

would not be lost merely because some vehicles pay

tax even though they may not use the roads.

Learned counsel urged that under entry 57 list II

once the vehicle is suitable for use on road, the tax

can be imposed. Learned counsel, therefore,

submitted that if a statute fixes a charge for

convenience or service provided by the State and

imposes the tax upon those who avail themselves of

such service or convenience the freedom of trade

and commerce will not be impeded. As long as the

dealer/trader has a choice to use the goods brought

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into the local area the levy on such entry is

compensatory. Learned counsel submitted that

Article 304(a) coupled with the test of

reasonableness as applied to fiscal measures shows

that a tax which is non-discriminatory would be

presumed to be compensatory if it has some

relation to the facilities provided. Similarly, on the

converse side a tax which is discriminatory would

be hit by Article 301. Shri Dwivedi lastly submitted

that in the case of Bihar Chamber of Commerce2

two principles were propounded. It was reiterated

that there should be some connection between a tax

and the facilities. To that extent learned counsel

submitted that there is no discord with the

judgment of this court in the case of Automobile

Transport6. The second principle propounded was

that it would be permissible to consider in the

context of entry tax that the whole of the State is

divided into local areas and, therefore, the court

held that it would be permissible to consider

various facilities provided by the State in all the

local areas. Learned counsel submitted that this

second principle/proposition should be followed by

a caveat or a rider to the effect that the traders who

pay the tax in a local area should be shown to have

been provided with substantial facilities as a class.

Learned counsel submitted that subject to above

caveat/rider there was no need to overrule the

judgments of this court in the case of Bhagatram1

and in the case of Bihar Chamber of Commerce2.

Shri Dinesh Dwivedi, learned senior counsel

appearing for the State of Uttar Pradesh and Shri B.

Sen, learned senior counsel appearing for the State

of Rajasthan substantially adopted the submissions

made by S/Shri P.P. Rao and Rakesh Dwivedi,

learned senior counsel.

ANALYSIS OF THE RELEVANT PROVISIONS OF

PART-XIII:

The relevant provisions are as follows:

"301. Freedom of trade, commerce

and intercourse. \026 Subject to the other

provisions of this Part, trade, commerce

and intercourse throughout the territory

of India shall be free.

302. Power of Parliament to impose

restrictions on trade, commerce and

intercourse. \026 Parliament may by law

impose such restrictions on the freedom

of trade, commerce or intercourse

between one State and another or within

any part of the territory of India as may

be required in the public interest.

303. Restrictions on the legislative

powers of the Union and of the States

with regard to trade and commerce. \026

(1) Notwithstanding

anything in article 302, neither

Parliament nor the Legislature

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of a State shall have power to

make any law giving, or

authorizing the giving of, any

preference to one State over

another, or making, or

authorizing the making of, any

discrimination between one

State and another, by virtue of

any entry relating to trade and

commerce in any of the Lists in

the Seventh Schedule.

(2) Nothing in clause (1)

shall prevent Parliament from

making any law giving, or

authorizing the giving of, any

preference or making, or

authorizing the making of, any

discrimination if it is declared

by such law that it is necessary

to do so for the purpose of

dealing with a situation arising

from scarcity of goods in any

part of the territory of India.

304. Restrictions on trade,

commerce and intercourse among

States. \026 Notwithstanding anything in

article 301 or article 303, the Legislature

of a State may by law-

(a) impose on goods imported

from other States or the

Union territories any tax

to which similar goods

manufactured or

produced in that State are

subject, so, however, as

not to discriminate

between goods so

imported and goods so

manufactured or

produced; and

(b) impose such reasonable

restrictions on the

freedom of trade,

commerce or intercourse

with or within that State

as may be required in the

public interest:

Provided that no Bill or amendment

for the purposes of clause (b) shall be

introduced or moved in the Legislature

of a State without the previous sanction

of the President."

INTRODUCTION:

Section 8 of Article 1 of the U.S. Constitution

contains what is called "Commerce Clause", which

regulates trade and commerce. Keeping in mind the

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dual form of government in USA and the concept of

"Police Power" vis-`-vis the "Taxing Power", the U.S.

Supreme Court has held that the commerce power

embodied in the commerce clause implies the power

to regulate; that is the power to prescribe the rule

by which commerce is to be governed (See:

Constitutional Law by Stone). Section 8 of Article 1

is an authorization in favour of the Congress to

enact laws for the protection and encouragement of

commerce among the States. By its own force, it

creates an area of trade free from interference by

the States. Therefore, the commerce clause is per

se a limitation upon the power of the States and is

not dependent upon the law being enacted. It

prohibits the States from enacting a law which

impedes free flow of trade between the States.

On the other hand, section 92 of the

Australian Constitution provides for freedom of

trade and commerce. It does not seek to regulate as

in case of commerce clause. However, it has been

held in numerous decisions of the Privy Council and

the Australian High Courts that section 92 leaves

open the regulation of trade and commerce at all

events until the regulation is enacted provided it

does not impede the true freedom of inter-State

commerce. This reasoning is based on the principle

that all trade and commerce must be conducted

subject to law. Thus, we have the difference

between taxing and regulatory laws. This is how

the concept of "regulatory charges" came about.

Article 301 is inspired by section 92 of the

Australian Constitution when it refers to freedom of

trade and commerce, however, Article 301 is subject

to limitations and conditions in Articles 302, 303

and 304 which are borrowed from the commerce

clause under Article 1 of the US Constitution.

Therefore, Part-XIII is an amalgam of the United

States and Australian Constitutions which brings

out the difference between regulatory and taxing

powers. This is how the concept of Payment for

Revenue and concept of Payment for Regulation

arose. This is how the regulatory power stood

excluded from the taxing power and on that

reasoning in Automobile Transport6 case, this

Court took the view that compensatory taxes

constitute an exception to Article 301. It is a

judicially evolved concept. However, the basis of

that concept was not discussed by this Court in

that case which we have done in this case. Suffice

it to state at this stage that the basis of special

assessments, betterment charges, fees, regulatory

charges is "recompense/reimbursement" of the cost

or expenses incurred or incurrable for providing

services/facilities based on the principle of

equivalence unlike taxes whose basis is the concept

of "burden" based on the principle of ability to pay.

At this stage, we may clarify that in the above case

of Automobile Transport6, this Court has equated

regulatory charges with compensatory taxes and

since it is the view expressed by a Bench of seven

Judges, we have to proceed on that basis. The fall-

out is that compensatory tax becomes a sub-class of

fees.

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SCOPE OF ARTICLES 301, 302 AND 304:

Article 301 states that subject to the other

provisions of Part-XIII, trade, commerce and

intercourse throughout India shall be free. It is not

freedom from all laws but freedom from such laws

which restrict or affect activities of trade and

commerce amongst the States. Although Article

301 is positively worded, in effect, it is negative as

freedom correspondingly creates general limitation

on all legislative power to ensure that trade,

commerce and intercourse throughout India shall

be free. Article 301, therefore, refers to freedom

from laws which go beyond regulations which

burdens, restricts or prevents the trade movement

between States and also within the State. Since

"freedom" correspondingly imposes "limitation", we

have the doctrine of "direct and immediate effect" of

the operation of the impugned law on the freedom of

trade and commerce in Article 301 as enunciated in

Atiabari Tea Co.4 .

Article 301 is, therefore, not only an

authorization to enact laws for the protection and

encouragement of trade and commerce amongst the

States but by its own force creates an area of trade

free from interference by the State and, therefore,

Article 301 per se constitutes limitation on the

power of the State. Article 301 is, however,

subject to the other provisions of Articles 302, 303

and 304. It states that subject to other provisions

of Part-XIII, trade, commerce and intercourse

throughout India shall be free.

Article 301 is binding upon the Union

Legislature and the State Legislatures, but

Parliament can get rid of the limitation imposed by

Article 301 by enacting a law under Article 302.

Similarly, a law made by the State Legislature in

compliance with the conditions imposed by Article

304 shall not be hit by Article 301. Article 301 thus

provides for freedom of inter-State as well as intra-

State trade and commerce subject to other

provisions of Part-XIII and correspondingly it

imposes a general limitation on the legislative

powers which limitation is relaxed under the

following circumstances:

a) Limitation is relaxed in favour of the

Parliament under Article 302, in

which case Parliament can impose

restrictions in public interest.

Although the fetter is limited

enabling the Parliament to impose

by law restrictions on the freedom of

trade in public interest under Article

302, nonetheless, it is clarified in

clause (1) of Article 303 that

notwithstanding anything contained

in Article 302, the Parliament is not

authorized even in public interest,

in the making of any law, to give

preference to one State over

another. However, the said

clarification is subject to one

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exception and that too only in

favour of the Parliament, where

discrimination or preference is

admissible to the Parliament in

making of laws in case of scarcity.

This is provided in clause (2) of

Article 303.

b) As regards the State Legislatures,

apart from the limitation imposed by

Article 301, clause (1) of Article 303

imposes additional limitation,

namely, that it must not give

preference or make discrimination

between one State or another in

exercise of its powers relating to

trade and commerce under Entry 26

of List-II or List-III. However, this

limitation on the State Legislatures

is lifted in two cases, namely, it may

impose on goods imported from

sister State(s) or Union Territories

any tax to which similar goods

manufactured in its own State are

subjected but not so as to

discriminate between the imported

goods and the goods manufactured

in the State [See Clause (a) of Article

304]. In other words, clause (a) of

Article 304 authorizes a State

Legislature to impose a non-

discriminatory tax on goods

imported from sister State(s), even

though it interferes with the freedom

of trade and commerce guaranteed

by Article 301. Secondly, the ban

under Article 303(1) shall stand

lifted even if discriminatory

restrictions are imposed by the State

Legislature provided they fulfill the

following three conditions, namely,

that such restrictions shall be in

public interest; they shall be

reasonable; and lastly, they shall be

subject to the procurement of prior

sanction of the President before

introduction of the bill.

Broadly, the above analysis of the scheme of

Articles 301 to 304 shows that Article 304 relates to

the State Legislature while Article 302 relates to the

Parliament in the matter of lifting of limitation,

which, as stated above, flows from the freedom of

trade and commerce guaranteed under Article 301.

Article 304 also confers upon the State Legislature

power to lift the limitations imposed on it by Article

301 and clause (1) of Article 303. This aspect is

important because the doctrine of "direct and

immediate effect" which is mentioned in Atiabari

Tea Co.4 emerges from the concept of "limitation"

embodied in Article 301. It is this doctrine of direct

and immediate effect which constitutes the basis of

the working test propounded vide para 19 in

Automobile Transport6. Therefore, whenever the

law is impugned as violative of Article 301, the

Courts will have to examine the effect of the

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operation of the impugned law on the inter-State

and the intra-State movement of goods, which

movement constitutes an integral part of trade.

We have examined and analyzed the relevant

provisions of Part-XIII and particularly Article 301

as we are required to lay down the parameters of

compensatory tax vis-`-vis Article 301, as indicated

vide para 27 of the referral order.

GENERIC CONCEPT OF COMPENSATORY TAX:

INTRODUCTION:

The concept of compensatory tax is not there

in the Constitution but is judicially evolved in

Automobile Transport6 as a part of regulatory

charge. Consequently, we have to go into concepts

and doctrines of taxing powers vis-`-vis regulatory

powers, particularly when the concept of

compensatory tax was judicially crafted as an

exception to Article 301 in Automobile Transport6.

DIFFERENCE BETWEEN EXERCISE OF TAXING

AND REGULATORY POWER:

In the generic sense, tax, toll, subsidies etc.

are manifestations of the exercise of the taxing

power. The primary purpose of a taxing statute is

the collection of revenue. On the other hand,

regulation extends to administrative acts which

produces regulative effects on trade and commerce.

The difficulty arises because taxation is also used as

a measure of regulation. There is a working test to

decide whether the law impugned is the result of the

exercise of regulatory power or whether it is the

product of the exercise of the taxing power. If the

impugned law seeks to control the conditions under

which an activity like trade is to take place then

such law is regulatory. Payment for regulation is

different from payment for revenue. If the

impugned taxing or non-taxing law chooses an

activity, say, movement of trade and commerce as

the criterion of its operation and if the effect of the

operation of such a law is to impede the activity,

then the law is a restriction under Article 301.

However, if the law enacted is to enforce discipline

or conduct under which the trade has to perform or

if the payment is for regulation of conditions or

incidents of trade or manufacture then the levy is

regulatory. This is the way of reconciling the

concept of compensatory tax with the scheme of

Articles 301, 302 and 304. For example, for

installation of pipeline carrying gas from Gujarat to

Rajasthan, which passes through M.P., a fee

charged to provide security to the pipeline will come

in the category of manifestation of regulatory power.

However, a tax levied on sale or purchase of gas

which flows from that very pipe is a manifestation of

exercise of the taxing power. This example indicates

the difference between taxing and regulatory powers

[See: Essays in Taxation by Seligman].

DIFFERENCE BETWEEN "A TAX", "A FEE" AND

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"A COMPENSATORY TAX":

PARAMETERS OF COMPENSATORY TAX: -

As stated above, in order to lay down the

parameters of a compensatory tax, we must know

the concept of taxing power.

Tax is levied as a part of common burden. The

basis of a tax is the ability or the capacity of the

taxpayer to pay. The principle behind the levy of a

tax is the principle of ability or capacity. In the case

of a tax, there is no identification of a specific

benefit and even if such identification is there, it is

not capable of direct measurement. In the case of a

tax, a particular advantage, if it exists at all, is

incidental to the States' action. It is assessed on

certain elements of business, such as, manufacture,

purchase, sale, consumption, use, capital etc. but

its payment is not a condition precedent. It is not a

term or condition of a licence. A fee is generally a

term of a licence. A tax is a payment where the

special benefit, if any, is converted into common

burden.

On the other hand, a fee is based on the

"principle of equivalence". This principle is the

converse of the "principle of ability" to pay. In the

case of a fee or compensatory tax, the "principle of

equivalence" applies. The basis of a fee or a

compensatory tax is the same. The main basis of a

fee or a compensatory tax is the quantifiable and

measurable benefit. In the case of a tax, even if

there is any benefit, the same is incidental to the

government action and even if such benefit results

from the government action, the same is not

measurable. Under the principle of equivalence, as

applicable to a fee or a compensatory tax, there is

an indication of a quantifiable data, namely, a

benefit which is measurable.

A tax can be progressive. However, a fee or a

compensatory tax has to be broadly proportional

and not progressive. In the principle of equivalence,

which is the foundation of a compensatory tax as

well as a fee, the value of the quantifiable benefit is

represented by the costs incurred in procuring the

facility/services which costs in turn become the

basis of reimbursement/recompense for the

provider of the services/facilities. Compensatory

tax is based on the principle of "pay for the value".

It is a sub-class of "a fee". From the point of view of

the Government, a compensatory tax is a charge for

offering trading facilities. It adds to the value of

trade and commerce which does not happen in the

case of a tax as such. A tax may be progressive or

proportional to income, property, expenditure or

any other test of ability or capacity (principle of

ability). Taxes may be progressive rather than

proportional. Compensatory taxes, like fees, are

always proportional to benefits. They are based on

the principle of equivalence. However, a

compensatory tax is levied on an individual as a

member of a class, whereas a fee is levied on an

individual as such. If one keeps in mind the

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"principle of ability" vis-`-vis the "principle of

equivalence", then the difference between a tax on

one hand and a fee or a compensatory tax on the

other hand can be easily spelt out. Ability or

capacity to pay is measurable by property or rental

value. Local rates are often charged according to

ability to pay. Reimbursement or recompense are

the closest equivalence to the cost incurred by the

provider of the services/facilities. The theory of

compensatory tax is that it rests upon the principle

that if the government by some positive action

confers upon individual(s), a particular measurable

advantage, it is only fair to the community at large

that the beneficiary shall pay for it. The basic

difference between a tax on one hand and a

fee/compensatory tax on the other hand is that the

former is based on the concept of burden whereas

compensatory tax/fee is based on the concept of

recompense/reimbursement. For a tax to be

compensatory, there must be some link between the

quantum of tax and the facility/services. Every

benefit is measured in terms of cost which has to be

reimbursed by compensatory tax or in the form of

compensatory tax. In other words, compensatory

tax is a recompense/reimbursement.

In the context of Article 301, therefore,

compensatory tax is a compulsory contribution

levied broadly in proportion to the special benefits

derived to defray the costs of regulation or to meet

the outlay incurred for some special advantage to

trade, commerce and intercourse. It may

incidentally bring in net-revenue to the government

but that circumstance is not an essential ingredient

of compensatory tax.

Since compensatory tax is a judicially evolved

concept, understanding of the concept, as discussed

above, indicates its parameters.

To sum up, the basis of every levy is the

controlling factor. In the case of "a tax", the levy is

a part of common burden based on the principle of

ability or capacity to pay. In the case of "a fee", the

basis is the special benefit to the payer (individual

as such) based on the principle of equivalence.

When the tax is imposed as a part of regulation or

as a part of regulatory measure, its basis shifts from

the concept of "burden" to the concept of

measurable/quantifiable benefit and then it

becomes "a compensatory tax" and its payment is

then not for revenue but as reimbursement/

recompense to the service/facility provider. It is

then a tax on recompense. Compensatory tax is by

nature hybrid but it is more closer to fees than to

tax as both fees and compensatory taxes are based

on the principle of equivalence and on the basis of

reimbursement/recompense. If the impugned law

chooses an activity like trade and commerce as the

criterion of its operation and if the effect of the

operation of the enactment is to impede trade and

commerce then Article 301 is violated.

BURDEN ON THE STATE:

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Applying the above tests/parameters,

whenever a law is impugned as violative of Article

301 of the Constitution, the Court has to see

whether the impugned enactment facially or

patently indicates quantifiable data on the basis of

which the compensatory tax is sought to be levied.

The Act must facially indicate the benefit which is

quantifiable or measurable. It must broadly

indicate proportionality to the quantifiable benefit.

If the provisions are ambiguous or even if the Act

does not indicate facially the quantifiable benefit,

the burden will be on the State as a service/facility

provider to show by placing the material before the

Court, that the payment of compensatory tax is a

reimbursement/recompense for the quantifiable/

measurable benefit provided or to be provided to its

payer(s). As soon as it is shown that the Act

invades freedom of trade it is necessary to enquire

whether the State has proved that the restrictions

imposed by it by way of taxation are reasonable and

in public interest within the meaning of Article

304(b) [See: para 35 of the decision in the case of

Khyerbari Tea Co. Ltd. & Anr. v. State of Assam

& Ors., reported in AIR 1964 SC 925].

SCOPE OF ARTICLES 301, 302 & 304 VIS-@-VIS

COMPENSATORY TAX:

As stated above, taxing laws are not excluded

from the operation of Article 301, which means that

tax laws can and do amount to restrictions on the

freedom guaranteed to trade under Part-XIII of the

Constitution. This principle is well settled in the

case of Atiabari Tea Co.4 . It is equally important

to note that in Atiabari Tea Co.4, the Supreme

Court propounded the doctrine of "direct and

immediate effect". Therefore, whenever a law is

challenged on the ground of violation of Article 301,

the Court has not only to examine the pith and

substance of the levy but in addition thereto, the

Court has to see the effect and the operation of the

impugned law on inter-State trade and commerce as

well as intra-State trade and commerce.

When any legislation, whether it would be a

taxation law or a non-taxation law, is challenged

before the court as violating Article 301, the first

question to be asked is: what is the scope of the

operation of the law? Whether it has chosen an

activity like movement of trade, commerce and

intercourse throughout India, as the criterion of its

operation? If yes, the next question is: what is the

effect of operation of the law on the freedom

guaranteed under Article 301? If the effect is to

facilitate free flow of trade and commerce then it is

regulation and if it is to impede or burden the

activity, then the law is a restraint. After finding

the law to be a restraint/restriction one has to see

whether the impugned law is enacted by the

Parliament or the State Legislature. Clause (b) of

Article 304 confers a power upon the State

Legislature similar to that conferred upon

Parliament by Article 302 subject to the following

differences:_

(a) While the power of Parliament

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under Article 302 is subject to the

prohibition of preference and

discrimination decreed by Article

303(1) unless Parliament makes the

declaration under Article 303(2),

the State power contained in Article

304(b) is made expressly free from

the prohibition contained in Article

303(1) because the opening words

of Article 304 contains a non-

obstante clause both to Article 301

and Article 303.

(b) While the Parliament's power to

impose restrictions under Article

302 is not subject to the

requirement of reasonableness, the

power of the State to impose

restrictions under Article 304 is

subject to the condition that they

are reasonable.

(c) An additional requisite for the

exercise of the power under Article

304(b) by the State Legislature is

that previous Presidential sanction

is required for such legislation.

WHY WAS THE MATTER PLACED BEFORE A

BENCH OF FIVE JUDGES:

The concept of compensatory taxes was

propounded in the case of Automobile Transport6

in which compensatory taxes were equated with

regulatory taxes. In that case, a working test for

deciding whether a tax is compensatory or not was

laid down. In that judgment, it was observed that

one has to enquire whether the trade as a class is

having the use of certain facilities for the better

conduct of the trade/business. This working test

remains unaltered even today.

As stated above, in the post 1995 era, the said

working test propounded in the Automobile

Transport6 stood disrupted when in Bhagatram's

case1, a Bench of three Judges enunciated the test

of "some connection" saying that even if there is

some link between the tax and the facilities

extended to the trade directly or indirectly, the levy

cannot be impugned as invalid. In our view, this

test of "some connection" enunciated in

Bhagatram's case1 is not only contrary to the

working test propounded in Automobile

Transport's case6 but it obliterates the very basis

of compensatory tax. We may reiterate that when a

tax is imposed in the regulation or as a part of

regulatory measure the controlling factor of the levy

shifts from burden to reimbursement/recompense.

The working test propounded by a Bench of seven

Judges in the case of Automobile Transport6 and

the test of "some connection" enunciated by a

Bench of three Judges in Bhagatram's case1

cannot stand together. Therefore, in our view, the

test of "some connection" as propounded in

Bhagatram's case1 is not applicable to the concept

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of compensatory tax and accordingly to that extent,

the judgments of this Court in Bhagatram

Rajeevkumar v. Commissioner of Sales Tax,

M.P.1 and State of Bihar v. Bihar Chamber of

Commerce2 stand overruled.

Before concluding, we may point out that

parties before us have taken more or less extreme

positions and, therefore, we have not examined the

arguments in seriatim.

CONCLUSION:

In our opinion, the doubt expressed by the

referring Bench about the correctness of the

decision in Bhagatram's case1 followed by the

judgment in the case of Bihar Chamber of

Commerce2 was well-founded.

We reiterate that the doctrine of "direct and

immediate effect" of the impugned law on trade and

commerce under Article 301 as propounded in

Atiabari Tea Co. Ltd. v. State of Assam4 and the

working test enunciated in Automobile Transport

(Rajasthan) Ltd. v. State of Rajasthan6 for

deciding whether a tax is compensatory or not vide

para 19 of the report, will continue to apply and the

test of "some connection" indicated in para 8 of the

judgment in Bhagatram Rajeevkumar v.

Commissioner of Sales Tax, M.P.1 and followed in

the case of State of Bihar v. Bihar Chamber of

Commerce2, is, in our opinion, not good law.

Accordingly, the constitutional validity of various

local enactments which are the subject matters of

pending appeals, special leave petitions and writ

petitions will now be listed for being disposed of in

the light of this judgment.