Budget 2020: It’s about time to set in motion a cess-free regime

By Tarun Jain

There is a ‘tax rate’ and then there is an ‘effective tax rate’. This is how tax advisors inform the client. The former reflects the basic rate of tax whereas the latter is the actual tax incidence, which may increase or decrease, depending upon the fine print of the tax law.

The increase, generally, is on account of various cesses and surcharges which are imposed for specific reasons. For example, in 2004 the then Finance Minister implored upon the Government’s priority for providing basic education to all children to introduce an Education Cess, to be computed as a percentage of almost all Union taxes in force. In 2007 a new cess – Secondary and Higher Education Cess (SHE Cess) – was imposed “to fulfil the commitment of the Government to provide and finance secondary and higher education”. The list of cesses is endless.

There is a Constitutional justification for levy of such cesses. Considering that there is an upper hand to the Union Government, the Constitution provides for mandatory devolution of a share of the Union’s tax proceeds with the States.

For illustration, in terms of the XIV Finance Commission’s recommendations, for every 100 rupees of taxes collected by Government of India, 42 was the share of the States. In wake of such considerations and in order to permit the Union Government to additionally augment its resources, Article 271 of the Constitution allow levy of ‘surcharge for the purpose of Union’. Such additional levies, being earmarked for specific purposes, are not required to be shared with the States. This has led to proliferation of a wide variety of surcharges and cesses, even though they constitute a ‘tax’ both in form and spirit.

The purpose of levy of a cess meant for a dedicated objective, however, is lost if its proceeds are not utilized for such purpose. For example, the February 2019 report of the CAG is on record to highlight that despite 94k crores of SHE Cess being collected till 2017, the utilization of such fund was not operationalized. In such circumstances, speaking from a policy-perspective, such cesses are no different from ordinary taxes in which cases the Government is not obliged to utilize the proceeds for any specific purpose.

In addition, there cannot be any over-emphasis in highlighting that progressive introduction of cesses increase compliance woes and are a hot-bed for litigation. Neither from a tax-administration nor a taxpayer perspective, either of these ramifications are acceptance. They also muddle formulation of a coherent tax-policy, besides obviously diluting the tax-certainty cannon, at the expanse of petty gains, given that cesses generally carry a low rate.

No doubt, a number of indirect tax related cesses were discontinued with the introduction of GST regime, but the state-of-affairs is far from optimal. In fact, even under the GST regime introduction of ‘sugar cess’ is a bone-of-contention between the sugar producing and consuming States. Mercifully, its levy still continues to be debated, though that is not the case with ‘flood cess’ to which the GST Council has consented, and which is currently in vogue in State of Kerala.

The flip flop of judicial opinion also adds to the continuing woes of the taxpayers. In 2017 the Supreme Court in SRD Nutrients had decisively opined that Education Cesses and other cesses are in nature of ‘piggy-back’ levies. Thus, when the main levy was exempt, the exemption should naturally be extended to cesses.

On such premise, lakhs of taxpayers – who had established their units in a host of industrially backward states relying the tax exemptions offered to them – heaved a sigh of relief as it implied negation of the claims of tax officers that notwithstanding the exemption from the main tax (here Central Excise duty), the cesses continued to remain payable.

Again, in early 2019 the Supreme Court in Bajaj Auto applied the same principle to extend exemption from National Calamity Contingent duty (NCCD) which was levied as a percentage of central excise duty and the latter duty was unconditionally exempt. Here the Supreme Court categorically observed that cesses / additional duties are in the nature of a surcharge and “bear the same character as those respective taxes to which the surcharge is appended”, thereby also covered within scope of exemption.

Last month, however, a larger bench of the Supreme Court in Unicorn Industries has reversed both these decisions. It opined that there is no exemption by inference and unless the Government specifically exempts cesses, the fact that the main tax is exempt is irrelevant to claim to exemption from cess. Even if this proposition may be legally sound, it creates an anomalous position that the rationale for granting exemption is virtually lost; the taxpayer must nonetheless undertake tax compliance and discharge the innocuous yet confirmed liability on account of these cesses.

There is yet another reason to revisit the cess structure. Let us take the illustration of exemption on account of export extended under the Foreign Trade Policy (FTP). Credit scrips are issued under the FTP by the Ministry of Commerce and Industry (MOC) which can be utilized for payment of customs duties on import of raw materials, thus obviating blockage of working capital which can be gainfully employed in manufacturing the final export goods.

On January 10, 2020 the Ministry of Finance (MOF) has issued a circular to the effect that such scrips issued by MOC are at best relevant for basic customs duty and cannot be utilized towards ‘Social Welfare Surcharge’, which is leviable as a cess on imported goods. The Circular, examined legally, is right to deny the benefit of the scrips to such surcharge. Logically extended, indeed there may be small revenue gains by compelling the Indian manufacturers to pay the Surcharge by denying benefit of the scrips. However, the moot question is that does it no interfere with the larger policy consideration that taxes should not be exported? This is a clear case of getting lost in detail to allow blurring of larger policy considerations.

A heart-felt expectation for both the taxpayer and the consumer would, therefore, be that the upcoming Budget revisits the tax-policy rationale for continued levy of cesses and surcharges. If indeed revenue-collection is an objective, let that be collected in form a tax simplicitor. The Government is also free to determine the utilization of proceeds of such levy instead of being tied down to specific objectives, as is the case with cess. Such simplification will also bridge the gap between the tax rate and effective tax-rate, streamlining compliance and closing dispute-avenues.

Tarun Jain is Partner, BMR Legal. Views are personal