Supreme Court strikes down levy of IGST on Ocean Freight

The apex court upholds the Gujarat High Court’s ruling in Mohit Minerals case and declares the CBIC notifications imposing 5% IGST on ocean freight under RCM as ultra vires and unconstitutional.

Introduction

The Indian taxation landscape witnessed a significant transformation when the Supreme Court of India delivered its landmark judgment in the case of Union of India vs. Mohit Minerals Private Limited [1]. This pivotal ruling addressed one of the most contentious issues in the Goods and Services Tax regime – the levy of Integrated Goods and Services Tax (IGST) on ocean freight under the Reverse Charge Mechanism (RCM) for Cost, Insurance, and Freight (CIF) import contracts.

The Supreme Court’s decision to uphold the Gujarat High Court’s ruling and declare the Central Board of Indirect Taxes and Customs (CBIC) notifications imposing 5% IGST on ocean freight as ultra vires and unconstitutional has far-reaching implications for international trade, import-export businesses, and the broader GST framework in India. This judgment has effectively resolved the double taxation concerns that had been plaguing importers across the country since the implementation of GST in 2017.

Background and Context of the Case

The Genesis of the Dispute

Mohit Minerals Private Limited, a company engaged in importing non-coking coal from Indonesia, South Africa, and the United States through ocean transportation on a CIF basis, found itself at the center of a legal battle that would reshape India’s indirect tax landscape [2]. The company challenged the validity of specific notifications issued by the CBIC that imposed IGST on ocean freight services under the reverse charge mechanism.

The dispute arose from the implementation of two critical notifications: Notification No. 8/2017-Integrated Tax (Rate) dated June 28, 2017, and Notification No. 10/2017-Integrated Tax (Rate) dated June 28, 2017. These notifications created a framework where importers were required to pay 5% IGST on ocean freight services under the reverse charge mechanism, even though the freight component was already included in the assessable value of imported goods subject to customs duty, which included IGST.

The Double Taxation Dilemma

The crux of the matter lay in the apparent double taxation that resulted from these notifications. Under CIF contracts, the ocean freight is an integral component of the total value of imported goods. When goods arrive at Indian ports, customs authorities assess the value of imports, which includes the cost of goods, insurance, and freight. This assessed value becomes the basis for levying customs duties, including IGST under the Customs Tariff Act, 1975.

However, the challenged notifications created an additional layer of taxation by requiring importers to pay IGST specifically on the ocean freight component under the reverse charge mechanism. This meant that the same freight component was being taxed twice – once as part of the customs duty assessment and again separately under RCM provisions.

Legal Framework and Statutory Provisions

Constitutional Framework of GST

The constitutional foundation of GST in India rests on Article 269A of the Constitution, which was introduced through the 101st Constitutional Amendment Act, 2016. Article 269A(1)(a) specifically provides that goods and services tax on supplies in the course of inter-state trade or commerce shall be levied and collected by the Government of India [3]. This constitutional provision establishes the framework for IGST levy on inter-state supplies.

Article 279A of the Constitution establishes the GST Council as a constitutional body with recommendatory powers. Article 279A(4) outlines the functions of the GST Council, including making recommendations on the rates of tax, exemptions, and the special provisions regarding certain states [4]. The Supreme Court in its judgment emphasized that while the GST Council plays a crucial role in tax policy formulation, its recommendations must align with constitutional principles and statutory provisions.

The IGST Act, 2017: Key Provisions

The Integrated Goods and Services Tax Act, 2017, forms the statutory backbone for IGST levy in India. Section 5 of the IGST Act deals with the levy and collection of IGST, while Section 5(3) specifically empowers the Central Government to specify categories of supply where tax shall be paid by the recipient under the reverse charge mechanism [5].

Section 7 of the IGST Act defines inter-state supply and is crucial to understanding the Supreme Court’s reasoning. Section 7(5)(b) provides that a supply shall be treated as inter-state supply where the location of the supplier is in a non-taxable territory and the location of the recipient is also in a non-taxable territory [6]. This provision became central to the court’s analysis of whether ocean freight services could be legitimately brought under the IGST net.

Analysis of Challenged Notifications

The Supreme Court scrutinized two primary notifications that formed the basis of the dispute:

Notification No. 8/2017-Integrated Tax (Rate) dated June 28, 2017 prescribed different rates for various categories of services supplied in inter-state trade or commerce. Entry 9(ii) of this notification specifically provided that IGST at 5% would be levied on supply of services by way of transportation of goods by a vessel from a place outside India up to customs station in India.

Notification No. 10/2017-Integrated Tax (Rate) dated June 28, 2017 specified categories of services where tax would be paid by the recipient under RCM. Entry 10 of this notification made services supplied by a person located in non-taxable territory to another person located in non-taxable territory, involving transportation of goods by vessel from outside India to Indian customs stations, taxable under RCM.

Supreme Court’s Analysis and Reasoning

Territorial Nexus and Jurisdictional Issues

The Supreme Court conducted a detailed analysis of the territorial nexus required for levying IGST on ocean freight services. The court observed that in CIF contracts, the ocean freight service is provided by foreign shipping companies to foreign exporters, with both parties located in non-taxable territories. The service of ocean transportation occurs primarily in international waters and foreign jurisdictions, with no substantial activity occurring within Indian territorial limits.

The court emphasized that for any tax to be constitutionally valid, there must be a sufficient territorial nexus between the taxing authority and the subject matter of taxation. In this case, the Indian importer was neither the supplier nor the recipient of the ocean freight service but merely a beneficiary who ultimately received the transported goods.

The Principle Against Double Taxation

Central to the Supreme Court’s reasoning was the fundamental principle against double taxation enshrined in Article 265 of the Constitution, which states that no tax shall be levied or collected except by authority of law. The court found that the ocean freight component was already included in the assessable value of imported goods under the Customs Tariff Act, 1975, and was thus subject to IGST as part of the customs duty structure.

The court distinguished between the aspect theory of taxation, which permits taxation of different aspects of the same transaction, and impermissible double taxation of the same value or amount. While the aspect theory might justify separate taxation of goods and services components, it cannot validate taxing the same component twice under different legal frameworks.

Reverse Charge Mechanism: Scope and Limitations

The Supreme Court examined the scope and constitutional validity of the reverse charge mechanism under Section 5(3) of the IGST Act, 2017. The court held that RCM is an exceptional mechanism designed to ensure tax compliance in specific scenarios where the supplier might not be in a position to discharge tax liability effectively.

However, the court found that applying RCM to ocean freight in CIF contracts was neither legally justified nor constitutionally permissible. The foreign shipping company providing ocean freight services to foreign exporters operates entirely outside Indian tax jurisdiction, and there exists no legal mechanism to shift this tax liability to Indian importers who are not parties to the freight contract.

Place of Supply Determination

A critical aspect of the court’s analysis involved determining the place of supply for ocean freight services. Under Section 13(8)(b) read with Section 2(6) of the IGST Act, 2017, the place of supply for transportation services is generally where the transportation begins. In the case of ocean freight for international trade, the transportation begins at foreign ports, placing the supply outside Indian tax jurisdiction.

The court rejected the argument that the place of supply should be considered as India merely because the goods ultimately reach Indian customs stations. The court emphasized that the place where the service is actually performed, rather than where its benefits are realized, determines the place of supply for taxation purposes.

Constitutional Validity and Article 14 Analysis

Equal Protection of Laws

The Supreme Court found that the challenged notifications violated Article 14 of the Constitution, which guarantees equal protection of laws. The court observed that the notifications created an arbitrary distinction between importers who entered into CIF contracts and those who opted for FOB (Free on Board) contracts.

Under FOB contracts, importers arrange their own transportation and are not subject to RCM on ocean freight, while CIF importers faced additional IGST liability under RCM despite having no direct contractual relationship with shipping service providers. This differential treatment lacked rational basis and violated the equality principle.

Arbitrariness and Unreasonableness

The court applied the test of arbitrariness established in various constitutional law precedents and found that imposing RCM liability on importers for services they neither contracted for nor directly received was manifestly arbitrary and unreasonable. The court emphasized that tax liability must have a rational connection to the taxpayer’s involvement in the taxable transaction.

Industry Impact and Economic Implications

Effect on Import Trade

The Supreme Court’s decision has significant positive implications for India’s import trade sector. Prior to this judgment, importers faced substantial additional tax burdens under RCM, which increased the cost of imports and affected the competitiveness of imported goods in the Indian market. The removal of this double taxation burden is expected to reduce import costs and improve trade facilitation.

Revenue Implications for Government

While the judgment results in revenue loss for the government, it strengthens the constitutional framework of taxation and enhances legal certainty for businesses. The decision reinforces the principle that tax collection must occur within constitutional bounds and cannot be justified merely on revenue considerations.

Impact on GST Jurisprudence

This judgment establishes important precedents for GST jurisprudence in India. It clarifies the limitations of the reverse charge mechanism and emphasizes the importance of territorial nexus in tax levy. The decision also reinforces the principle that the GST system, despite its broad coverage, must operate within constitutional constraints.

Subsequent Legislative Developments

Government’s Response Through Fresh Notifications

Following the Supreme Court’s judgment, the government issued several notifications to address the legal lacuna created by the striking down of the original notifications. Notification No. 11/2023-Integrated Tax (Rate) dated September 26, 2023, amended the original notification by omitting the controversial entry relating to ocean freight taxation [7].

Notification No. 12/2023-Integrated Tax (Rate) dated September 26, 2023, similarly amended the RCM notification to remove ocean freight services from its purview. Additionally, Notification No. 13/2023-Integrated Tax (Rate) dated September 26, 2023, introduced provisions for zero-rated IGST on transportation services from Indian customs stations to places outside India, demonstrating the government’s effort to align the law with the court’s reasoning [8].

Refund Mechanism for Affected Taxpayers

The judgment opened avenues for importers who had paid IGST under RCM on ocean freight to claim refunds. However, the refund process involves navigating various procedural requirements under the CGST Act, 2017, including time limitations and documentary evidence requirements.

Comparative Analysis with International Practices

Global Best Practices in Import Taxation

The Supreme Court’s decision aligns India’s taxation approach with international best practices where freight components in CIF contracts are typically taxed once as part of the customs valuation process. Most developed countries avoid double taxation of freight elements to maintain trade competitiveness and legal certainty.

WTO Compliance and Trade Facilitation

The judgment enhances India’s compliance with World Trade Organization principles, particularly the Trade Facilitation Agreement, which emphasizes reducing trade costs and avoiding duplicative procedures. By eliminating double taxation on ocean freight, India has strengthened its position as a trade-friendly destination.

Future Implications and Recommendations

Strengthening GST Framework

This judgment highlights the need for more careful drafting of GST notifications to ensure constitutional compliance. It suggests that future tax policy formulation should involve thorough constitutional scrutiny and consideration of double taxation implications.

Role of GST Council

While the GST Council plays a vital role in tax policy coordination, this judgment emphasizes that its recommendations must align with constitutional principles. The decision reinforces that the GST Council’s recommendatory powers do not override constitutional limitations on taxation.

Legal Certainty and Business Environment

The judgment contributes to legal certainty in India’s business environment by clarifying the boundaries of tax liability. It reinforces the principle that taxation must be based on clear legal authority and rational connection between the taxpayer and the taxable event.

Conclusion

The Supreme Court’s decision in Union of India vs. Mohit Minerals Private Limited represents a watershed moment in India’s indirect taxation history. By striking down the IGST levy on ocean freight under RCM, the court has reinforced fundamental constitutional principles while providing relief to the import trade sector from double taxation.

The judgment establishes important precedents regarding the scope of reverse charge mechanism, the requirement of territorial nexus for tax levy, and the prohibition against double taxation. It demonstrates the judiciary’s role in ensuring that tax collection occurs within constitutional bounds and that business operations are not subjected to arbitrary or unreasonable tax burdens.

This decision is expected to enhance India’s position as a trade-friendly destination and contribute to the overall efficiency of the GST system. It also provides valuable guidance for future tax policy formulation and emphasizes the importance of constitutional compliance in indirect tax legislation.

The ruling ultimately strengthens the rule of law in taxation matters and ensures that India’s tax system operates within the framework established by the Constitution, thereby protecting both taxpayer rights and the integrity of the tax collection process.

References

[1] Union of India vs. Mohit Minerals Private Limited, Civil Appeal Nos. 1390-1394 of 2022, Supreme Court of India, decided on May 19, 2022. Available at: https://indiankanoon.org/doc/98511521/ 

[2] Mohit Minerals Private Limited vs. Union of India, Gujarat High Court, Special Civil Application No. 18835 of 2017. Available at: https://taxbykk.com/wp-content/uploads/2023/03/Mohit-Minerals-Pvt.-Ltd.-Vs-Union-of-India-Gujarat-High-Court-IGST.pdf 

[3] The Constitution of India, Article 269A – Goods and services tax on inter-State trade or commerce. 

[4] The Constitution of India, Article 279A – Goods and Services Tax Council. 

[5] The Integrated Goods and Services Tax Act, 2017, Section 5 – Levy and collection of integrated tax. Available at: https://www.indiacode.nic.in/handle/123456789/2251 

[6] The Integrated Goods and Services Tax Act, 2017, Section 7 – Inter-State supply. Available at: https://cbic-gst.gov.in/hindi/IGST-bill-e.html 

[7] Notification No. 11/2023-Integrated Tax (Rate) dated September 26, 2023. Available at: https://cbic-gst.gov.in/hindi/integrated-tax-rate.html 

[8] Analysis on Supreme Court Judgment in Mohit Minerals by SBS and Company. Available at: https://sbsandco.com/analysis-on-supreme-court-judgment-in-mohit-minerals-striking-down-the-levy-on-ocean-freight/ 

[9] “SC Judgment in Mohit Minerals & Refund of IGST under RCM on Ocean Freight,” TaxGuru. Available at: https://taxguru.in/goods-and-service-tax/sc-judgment-mohit-minerals-refund-igst-rcm-ocean-freight.html