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July 11, 2012

No retroactive amendment to nullify a judgment: Gujarat High Court

In a recent judgment, in the case of Avani Exports v. Commissioner of Income Tax1, the Gujarat High Court has struck down the retroactive amendment made to the provisions of the Income-tax Act, 1961 (‘the Act’) which classified and levied onerous conditions only on a particular sect of taxpayers to be eligible to claim benefits on exporting goods out of India. The law was struck down broadly on two folds that while granting a benefit to taxpayers there cannot be unreasonable classification with unreasonable conditions and second, such an amendment cannot be retroactively made being substantial in nature. More so, a retroactive amendment cannot be made to nullify the effect of an adverse judgment when the Revenue has an option to prefer appeal to a higher forum against such a judgment.

Background

Pursuant to an order of the Supreme Court of India, a batch of writ petitions was taken up together for consideration by the Gujarat High Court. These writ petitions challenged the constitutional validity of the classifications made and the conditions levied by way of retroactive amendment to be eligible to claim export benefits by taxpayers. The amendment was made in 2005 with retroactive effect from 1998 and 2001 respectively.

Prior to the amendment, there were divergent views between the taxpayers (relying on a Tax Tribunal judgment2) and the Revenue on whether the profits earned on the transfer of Duty Entitlement Pass Book (‘DEPB’) and Duty Free Replenishment Certificate (‘DFRC’) should be included within the meaning of ‘profits’ for claiming deduction under export incentive scheme3 under the Act. For brevity, the importer of any goods for the purpose of exporting is entitled to claim refund of the Customs Duty paid or to have a credit entry in the DEPB/ DFRC. The excess credits lying in the DEPB/ DFRC could be transferred by the holder at a profit in the market. As per the amendment in 2005 which was retroactive, to claim such profits on transfer as a deduction under the export incentive scheme, the taxpayers were bifurcated based on export turnover such as, less than INR 100 Million and more than INR 100 Million. Exporters less than INR 100 Million were automatically entitled for the benefit of deduction. However, for exporters more than INR 100 Million, various sub-classifications and conditions were to be fulfilled.

Also, the Revenue held that the amended law would be enforceable only on those taxpayers whose assessment proceedings were still pending and for those taxpayers whose assessment proceedings were completed, they would not be subject to adverse impact of the new amendment.

Therefore, certain taxpayers challenged the retroactive amendment on the grounds that the broader classification on export turnover quantum was unconstitutional, additional conditions levied on exporters with turnover more than INR 100 Million was unconstitutional and unachievable, classification based on completed and pending assessments was improper and finally, the retroactive amendment on a substantial law was unconstitutional and unreasonable.

Contentions of the Petitioners

The petitioners put forth the following arguments before the High Court:

  • That the classification based on quantum of export turnover was arbitrary and unreasonable.

  • That the amendment places two taxpayers of the same class on different levels i.e. first, whose assessments have been completed and have become final and secondly, whose assessments are still pending. This leads to a situation where the taxpayers on completed assessments need not fulfill the conditions and benefits would still be available to them and on the other hand, for those taxpayers whose assessments are still pending are required to comply with the new conditions retroactively.

  • That the additional conditions levied for larger exporters were not realistic and are not achievable.

  • Finally, only procedural amendments can have retroactive effect and any amendment which is substantial in nature, cannot have retroactive effect unless it is beneficial to a taxpayer.

Contentions of the Revenue

The Revenue put forth the following arguments before the High Court:

  • The retroactive amendment did not seek to withdraw any benefit or concession already available to the taxpayers with regard to export of goods nor did it seek to levy any new charge of tax retroactively.

  • The Revenue contended that the legislature never intended to grant deductions on the profits made on the transfer of DEPB/DFRC as the same did not actually form part of the export per se and was to be considered as independent income and subject to tax. The view of the Tax Tribunal4 as relied by the taxpayers was incorrect and untenable in law. The Revenue further argued that in order to overcome this decision and avoid any unintended benefit, the retroactive amendment was made.

  • According to the Revenue the impugned amendment has in fact granted a new benefit which was not earlier available to the taxpayers but with categorization as small and medium exporters and for large exporters certain conditions were levied to avail this benefit.

Judgment of the Court

With regard to classification based on the quantum of export turnover, the Court held such a classification was not violative of the Indian Constitution and was reasonable under the taxing statutes.

However, on all other issues, the High Court held that the impugned retroactive amendment was violative of Article 14 of the Indian Constitution which enshrines equality before law and equal protection under law. In order to determine what kind of classification is permissible under Article 14, a reference was made to the observations of the Supreme Court in the case of Kerala Hotel and Restaurant Association v. State of Kerala5 which laid down the test of ‘palpable arbitrariness’ to judge the basis of classification of a taxing provision.

Further, the Court held that the discrimination between taxpayers based on completed and pending assessments amounts to palpable arbitrariness. The High Court opined that such discrimination violates Article 14 as there is no rationale nexus with the object of amendment, and therefore such classification fails the test of ‘palpable arbitrariness’.

As regards to whether the impugned amendment should be set aside on grounds of retroactive operation of a substantive amendment, the court held in favor of the petitioner. The High Court was of the view that after conferring a benefit to the taxpayer based on some specific conditions, for such benefit to be curtailed, it must be effective from a future date.

Interestingly, the High Court held that if the Revenue was aggrieved by the order of the Tax Tribunal, it ought to have preferred an appeal to a higher forum. Instead of that, in order to get rid of an order the Revenue cannot curtail existing benefits by introducing retroactive amendments. In order to emphasize on the point that the legislature must lawfully revalidate the law, the High Court referred to the case of Prithvi Cotton Mills Ltd v. Broach Borough Municipality6. The Court went on to hold that there was no defect in the original legislation and the Tax Tribunal has interpreted the language of a valid piece of legislation in a way, which benefits the taxpayers. In such a case, for overcoming the adverse decision of the Tribunal, the legislature cannot delete a valid piece of legislation and incorporate a totally new one with retroactive effect.

The Court concluded by saying that in this type of substantive amendment, the retroactive operation can be given only if it is for the benefit of the taxpayers and not in a case where even if it affects a fewer section of the taxpayers.

Analysis

A High Court in India is a constitutional authority which has the power of judicial review in determining the constitutionality of a law. Even if the decision is by a particular state’s High Court, if this decision goes unchallenged by the Revenue before the Supreme Court of India, then by passage of time the retroactive amendment would become unconstitutional as held by this High Court.

The timing of the decision is of significant importance especially in the wake of the recent retroactive amendment introduced by the Government of India in this year’s Budget to nullify the judgment of the Supreme Court in the case of Vodafone. The High Court in this case has categorically held that a retroactive amendment cannot be used as a tool to overcome adverse decisions of the courts.

Interestingly, the High Court has quashed the retroactive amendment which is based on completed and pending assessments with a view that delay in completing the assessments by the Revenue should not unduly burden the taxpayers and saddle them with new unexpected changes in law. Coincidentally, a similar circular dated May 29, 2012 was issued by the Central Board of Direct Taxes that no reopening would be made on those assessments which have been completed prior to April 1, 2012 on any indirect transfers which would be affected by the retroactive amendment to section 9 of the Act.

As discussed in our earlier hotlines, the retroactive amendment to section 9 has come by way of clarification and the Revenue will have substance to argue that it is not substantial in nature. However, it would be really interesting to wait and watch whether the Revenue would prefer an appeal against this High Court judgment to the Supreme Court and also the outcome of the recent writ petitions filed in the Calcutta High Court challenging the retroactive amendment to section 9 under the auspices of this judgment.


Shipra Padhi & Karthik Ranganathan


1 [2012] 23 taxmann.com 62 (Gujarat)

2 P.G. Enterprises P. Ltd. Vs. DCIT (2005) 93 I.T.D. 138 (Del.)

3 Section 80HHC of the Act

4 Supra Note 2

5 AIR 1990 SC 913

6 AIR 1970 SC 192

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