compensatry tax and freedom of trade

submitted to : APARNA MA’AM

Submitted by: Abhinandan Roy

ACKNOWLADGEMENT 3
RESEARCH METHODLOGY 4
INTRODUCTION 5
SCOPE OF THE ARTICLE 301 6

COURTS VIEW ON COMPENSATORY TAX 8

CONCLUSION 13
ACKNOWLEDGEMENT
The text reported in this project is the outcome of my own effort and and
no part of this project has been copied in any unauthorized and no part
of it has been incorporated without any due acknowledgement.

ABHINANDAN ROY
RESEARCH METHODLOGY
To understand the the term compensatory tax & freedom of trade. The article they
deal with and understandig the court’s over it. Here in the topic it has deal with the
view of court over the compansetory tax ans many more.

Coverage &Scope –
The duration or number of cases and nature of cases studied.
 INTRODUCTION

With Globalisation, industries require larger markets and as a country we cannot develop, if we try and
fragment every State and give liberty to them to levy entry taxes as per their whims and fancies.
Obviously States should not resort to such entry taxes for augmenting its revenues. Further Central
Government needs to ensure that they do not allow such controversies to rope in the proposed Goods and
Service Tax (GST) situation and they make it clear while implementing Goods and Services Tax (GST)
that States cannot levy any entry tax on goods received within the State for consumption, use, or sale
therein. In today’s world, corporate world need clarity whether a particular levy is applicable or not so
that they can accordingly decide on their end pricing to the consumer. As a country, we cannot keep so
many Companies in doubt. Most of the States levy tax on activities related to trade and commerce and it
is their major revenue source. But it would be violative of Article 301 under Indian Constitution if it
would impede the freedom of trade and commerce as it will affect the free flow of trade. As a result States
declare these types of taxes as compensatory and regulatory by saying that the imposition of tax is for
facilitating the trade and commerce by providing facilities like maintenance of roads, traffic lights, etc.
The main issue with which researcher is dealing in this research paper is that what should be the criteria
to decide whether the tax is compensatory or just for enhancing the revenue of government. So,
researcher has dealt with chapter XIII of Indian Constitution with several cases of Supreme Court and
analysed them to reach at a certain conclusion to abolish the vagueness of the concept (upto certain level)
of regulatory and compensatory tax.
 Scope of Article 301 of Indian Constitution:
1. One of the Constitutional aspirations is economic unity and the objective of Constitution is its safe
guarding its attainment and maintenance of that unity. As a result Part XIII (Trade, commerce and
intercourse within the territory of India) of the Constitution was created where Article 301-305 have
been created to ensure that State legislature subjected to regional and local pulls and do not create
trade barriers in future. These provisions deal with freedom of trade, commerce and intercourse
within the territory of India. The main provision is Article 301.
2. The framers of our Constitution while framing Article 301 had before them the experience of other
Constitutions, particularly of the U.S. and Australian. They did not pursue the U.S. model. They
pursued the Australian model, and hence they introduced certain significant changes. First change
was that they replaced the words “among the States” and “absolutely free” in section 92 of the
Australian Constitution by the words “throughout the territory of India” and “free” respectively in
Article 301 but there is not absolute freedom for trade. There are reasonable restrictions which can be
used for emergencies, maintaining public order, peace etc. The freedom provided by Article 301 is
not confined only to inter-State but also extends to intra-State trade and commerce.
3. The general rule that trade, commerce and intercourse throughout the territory of India shall be free
has been enacted by Article 301. The freedom that has been provided by Article 301 may be defined
as right to free movement of persons or things, tangible or intangible, commercial or non-
commercial, unobstructed by barriers, inter-State, i.e. trade and commerce which overflows the
boundary of one State and which extends to two or more States, or intraState, i.e. commerce which is
confined within the territory of State or any other obstacles operating as such barriers. All types of
obstructions and impediments to the free flow or movement of trade or non-commercial intercourse
offend Article 301.
4. The Constitution makers desired to promote free flow of trade and commerce in India because they
realised that economic unity and integration of the country provided the main sustaining force for the
stability. The main object of this Article is to break down the border barriers between the
Constitutional States and to make the entire territory of the country as a single unit with a view to
encouraging trade and commerce in the country.
5. The freedom of trade and commerce in Article 301 is subject to the provisions in Articles 302-307.
Parliament has been provided with the power to impose restrictions on the freedom of trade,
commerce and intercourse between one State and another or within any part of the territory of India,
but that must be in the public interest. This power is also not absolute because Parliament cannot
make any law with respect to trade and commerce which provides preference to one State over
another, or discriminates between one State and another. Parliament can make this type of law but
only in case of famine or scarcity of goods in part of India.
6. Tax can also be imposed on the goods imported from other State by State, if similar goods are
manufactured in that State also. State may impose reasonable restriction on the freedom of trade,
commerce and intercourse in public interest but this power is also restricted because State legislature
cannot make a law regarding trade and commerce that discriminates between the States and the other
restriction over the power of State legislature is that they cannot introduce the bill of imposing
restriction over trade and commerce in State legislature without the previous sanction of President.
7. Other provision is that if there would be any restrictions over trade and commerce under the existing
laws then they would be in force unless the president directs otherwise, Article 301 is also subjected
to the Article 19(6)(ii) of Indian Constitution.
8. After studying these provisions, an expression is created in mind that these all provisions are
exception to Article 301 but that cannot be true. Article 304 is an addition to Article 301 and it
prohibits the discrimination in inter-State trade, commerce and intercourse. Similarly Article 304(a)
prohibits the discriminatory taxes without the need to prove the violation of freedom under Article
301. Article 307 enables Parliament to establish an authority for carrying out the provisions of
Articles 301-304. All these provisions in no way restrain the freedom ensured in Article 301.
Court’s view on Compensatory Tax:
 Article 301 says that trade, commerce and intercourse throughout the territory of India shall be
free. This Article should be understood in such a manner that it facilitates trade and commerce
throughout the territory of India and it must allow some degree of regulatory control irrespective
of the restrictions imposed by Part XIII of Indian Constitution. And Hence, Regulatory measures
and compensatory tax should not be considered as violative of Article 301. The Indian Courts
have applied the concept of regulatory and compensatory taxation to the State taxation under
entries 56 and 57 of list II. The reason behind it is that compensatory and regulatory measures
facilitate, rather than hamper, the flow of trade and commerce1.
 It is pertinent to bear in mind that all taxation is not necessarily an impediment or a restraint in the
matter or trade, commerce and intercourse. Instead of being such impediments or restraints, they
may, on the other hand, also provide for improvement of different kinds of means of transport, for
example, in tea leaves growing areas, unless there are good roads, facility for transport of tea
leaves from farms to whole country may be difficult, costly and insufficient. In order to make new
roads as also to improve old ones, cess on the grower of tea leaves or others interested in the
transport of this commodity has to be imposed. It is the tax thus realized that makes it feasible for
opening new means of communication or for improving old ones. It cannot therefore, be said that
taxation in every case must mean an impediment or restraint against free flow of trade and
commerce2 .
 The researcher has observed that the concept of compensatory and regulatory tax is complex and
so many times it has affected the freedom of trade and commerce throughout the territory of India.
In this chapter researcher has tried to discuss the views of Supreme Court on different cases
regarding compensatory tax. The first case regarding this issue was Atiabari Tea Co. Ltd. v. State
of Assam3 and then at regular intervals SC gave its decisions in different cases but the main
problem was that SC could not able to give the reasonable method to levy compensatory tax4.
 In 2006, SC gave the verdict in Jindal Stainless Ltd. (2) v. State of Haryana5 , where the most
reasonable method of proportionality was found out and hence the complexity of determining the
compensatory tax came to an end.
 So, the researcher will discuss and analyze the decisions which have been given SC till Jindal6
case.
 In Atiabari Tea Co. Ltd. v. State of Assam7 , A tax was levied under Assam Taxation Act, 1954 by
the State of Assam on the carriage of tea by road or inland waterways which was held invalid
because the reason behind the levy of tax was to increase the revenue of State and thus "directly
affects the freedom of trade as contemplated by Article 301." The Supreme Court took the view
that the freedom guaranteed by Article 301 would become erroneous if the movement, transport,

1
Juhi Bansal, Entry Tax: Is it Constitutional?, available at http://www.servicetaxindia.co.in/forms/entrytax.pdf
2
Report of The Commission on Centre-State Relations, Evolution of the Centre-State Relations in India, Vol. 1,
(March 2010) available at http://interstatecouncil.nic.in/volume1.pdf
3
Atiabari Tea Co. Ltd. v. State of Assam, AIR 1961 SC 232 (Supreme Court of India).
4
Report and Recommendations of Sarkaria Commission, Trade, Commerce and Intercourse Within the Territory of
India, (January 1988) available at http://interstatecouncil.nic.in/CHAPTERXVIII.pdf
5
Jindal Stainless Ltd. (2) v. State of Haryana, AIR 2006 SC 2550 (Supreme Court of India)
6
Jindal Stainless Ltd., AIR 2006 SC 2550 (Supreme Court of India).
7
Atiabari Tea Co. Ltd. v. State of Assam, AIR 1961 SC 232 (Supreme Court of India).
 or the carrying of goods were allowed to be impeded, obstructed or hampered by the taxation
without satisfying the requirements of Article 302-304.
 In the course of judgement, Gajendragadkar, J. said that restrictions, freedom from which is
guaranteed by Article 301, would be such restrictions as directly and immediately restrict or
impede the free flow or movement of trade throughout the territory of India. On the other hand,
indirect or remote restrictions on the free flow or movement of trade would be permissible under
Article 301.
 The Court did not take into consideration the quantum of burden of tax, which by no means was
excessive. Simply because the tax was levied on 'movement' of goods, from one place to another,
it was held as violative of Article 301. And hence the taxation law was also declared as void. The
view set out in Atiabari was bound to have great adverse effect upon the financial autonomy of the
States. It would have rendered their taxing power under entries 56 and 57, List II. the Assam
Taxation Act, 1954 was not fulfilling the conditions under Article 304(b), it was amended in
Kheyrbari Tea Co. v. State of Assam8, where the same issue of levying tax to enhance State
revenue was arisen.
 The contention of State was that it was compensatory tax but as the tax was directly impeding the
free flow of trade, it was held violative of Article 301. The matter of Atiabari9 case was
reconsidered in Automobile Transport Ltd. v. State of Rajasthan10 by SC. In this case, the State of
Rajasthan had levied a tax on motor vehicles ( Rs. 60 on a motor car and Rs. 2000 on a goods
vehicle per year) used within the State in any public place or kept for use in the State. And hence,
the validity of the tax was challenged.
 The freedom of trade and commerce under Article 301 should not unduly interfere with the State
autonomy, and it should be consistent with an orderly society, the Supreme Court now ruled that
regulatory measures and compensatory taxes for the use of trading facilities were not hit by Article
301 as these did not hamper, but rather facilitated, trade, commerce and intercourse throughput the
territory of India. The main issue in this case was to deduce a working test to decide whether a tax
is compensatory or not because it was to enquire whether the trading people are having the use of
certain facilities for the better conduct of their business and paying not patently much more than
what is required for providing the facilities.
 A tax does not cease to be compensatory because the precise or specific amount collected is not
actually used in providing facilities. The Court had to define what a compensatory tax or
regulatory measure was. A regulatory measure, the Court said, is a measure which actually
facilitated trade, though it appeared to harm it. For instance, the rule that a merchant’s car loaded
with wares must stop at a red traffic signal is a purported restriction on the movement of trade, but
actually facilitates it, since it ensures that cars do not destroy each other, and in the process,
trade11.

8
Kheyrbari Tea Co. v. State of Assam, AIR 1964 SC 925 (Supreme Court of India)
9
Atiabari Tea Co., AIR 1961 SC 232.
10
Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan, AIR 1962 SC 1406 (Supreme Court of India)
11
V. Niranjan, Interstate Trade and Commerce: The Doctrine of Proportionality Reaffirmed, THE INDIAN
JOURNAL OF CONSTITUTIONAL LAW, (2008), available at http://www.indlaw.com/display.aspx?58B0AEB6-
20B3-46BA-8CEF-21E8411C23EF
 The concept of compensatory tax evolved in this case was something new as compared to
Atiabari12 case, the Court had dismissed the argument that the money collected through the tax
would be used to improve roads and waterways rather curtly by saying that there were other ways,
apart from the tax in question, to use the money, and that if the said object was intended to be
achieved by levying a tax on the carriage of goods, the same could be done only by satisfying
Article 304(b).
 The Court ruled that Article301 did not hit the tax, as it was a compensatory tax having been
levied for use of the roads provided for and maintained by the State. Thus, to this extent, the
majority view in Atiabari13 case was now overruled by Automobile. Since then the concept of
regulatory and compensatory taxes has become established in India with reference to entries 56
and 57, List II, and the concept has been applied in several cases, and progressively the Courts
have liberalized the concept so as to permit State taxation at a higher level14.
 In State of M.P. v. Bhailal Bhai15, a tax was imposed under Madhya Bharat Sales Tax Act, 1950
on sales of tobacco leaves, manufactured tobacco and tobacco used for bidi manufacturing and it
was payable at the point of sales by importer in Madhya Bharat. The petitioners contended that the
tax was unconstitutional as it was violative of Article 301. Das Gupta, J., held that the tax was
violative of Article 301 as it was directly impeding the freedom of trade and commerce. This case
was not considered as the exception under Article 304(a), because similar goods manufactured in
taxing State were not subjected to the impugned tax. And hence the final verdict went into the
favour of petitioners.
 In State of Assam v. Labanya Probha16 , tax was levied on motor vehicles with the rate of Rs. 56
per seat in State. The petitioner challenged the tax as violative of Article 301 due to impediment in
free flow of trade and commerce. Court rejected the plea by following the judgement in
Automobile Transport 17 case, and held that the tax law was only regulatory measure imposing
compensatory taxes for facilitating trade, commerce and intercourse.
 Later in Andhra Sugars Ltd. v. State of A.P.18, the validity of section 21 of The Andhra Pradesh
Sugarcane (Regulation of Supply and Purchase) Act, 1961, which imposed the tax on purchases of
all sugarcane required for use, consumption or sale in a factory and hence petitioner challenged
the tax as that it was violating Article 301.
 There was no discrimination between the sugarcane produced in the State and imported from
outside. The Court upheld the section and pointed out that generally a tax on the good does not
restrict the free flow and movement or transport of goods and hence it does not violate Article
301.
 After that in State of Madras v. Nataraja Mudaliar36, petitioner challenged the assessment under
the Central Sales Tax Act, 1956. Shah, J., observed that the tax under Central Act on inter-State
sales is in its essence a tax hampering movement of trade and commerce since by definition in the
act, a sale or purchase of goods is deemed to take place in the course of interState trade and
12
Atiabari Tea Co., AIR 1961 SC 232.
13
Atiabari Tea Co., AIR 1961 SC 232.
14
Akanksha Bhadouria, Are regulatory and compensatory taxes violative of article 301?, available at
http://www.legalserviceindia.com/articles/taxes_int.htm
15
State of M.P. v. Bhailal Bhai, AIR 1964 SC 1006 (Supreme Court of India)
16
State of Assam v. Labanya Probha, AIR 1967 SC 1575 (Supreme Court of India)
17
Automobile Transport, AIR 1962 SC 1406.
18
Andhra Sugars Ltd. v. State of A.P., AIR 1968 SC 599 (Supreme Court of India)
 commerce if the goods are transported from one State to another or if there would be transfer of
title deeds or documents to the goods from one State to another, and as a result it was held that the
tax fell within the prohibition of Article 301.
 However it was saved under Article 302 which empowers parliament to make a law in public
interest. In the final verdict Bachawat, J., upheld the tax by following the reasoning in Andhra
Sugars Ltd. v. State of A.P.,that generally a tax on sales of goods did not directly impede or
restrict the free flow or transport of goods.
 In Nazeria Motor Service v. State of A.P.37, in this case also there was a taxation act in Andhra
Pradesh which was levying tax on vehicles within the State in any public place or kept for use in
the State. As a result it was argued that the purpose of tax was only to raise the State revenue and
not facilitating the trade and commerce in State.
 It was not considered as compensatory or regulatory. Even though there had been compliance with
the proviso to Article 304(b) in the matter of obtaining the sanction to levy the tax but it was
always open to Court to reconsider the reasonableness of tax and also have power to inquire
whether the imposition was in public order. Hence in the final verdict Court held it as invalid and
declared the tax as void due to the violation of Article 301. Later in G.K. Krishnan v. State of
Tamil Nadu38 , The State of Tamil Nadu increased the motor vehicles tax from Rs. 30 to 100 per
seat per quarter and this was challenged as being violative of Article 301.
 The main issue was that whether a non-discriminatory tax levied by a State should be considered
as a restriction on trade and commerce because of the feeling that this would restrict the State
autonomy to levy taxes falling in the State legislative sphere? But the Supreme Court upheld the
tax. The Court Stated, "A compensatory tax is not a restriction upon the movement part of trade
and commerce. The tax should not go beyond a proper recompense to the State for the actual use
made of the physical facilities provided in the shape of a road19.
 In the instant case, the tax collections amounted to over Rs. 16 crores while the expenditure for the
year amounted to Rs. 19.51 crores and this amount did not include the grants to local governments
for the repair and maintenance of roads within their jurisdiction. The tax was thus held to be
compensatory and hence valid. The Supreme Court further liberalized the State taxing power by
upholding a State tax on passengers and goods carried on national highways.
 Further in Bolani Iron Ores v. State of Orissa20, A compensatory tax is levied to raise revenue to
meet the expenditure for building roads, maintaining them and for facilitating the movement and
regulation of traffic. The Supreme Court held that taxation under entry 57, List II, couldn’t surpass
the compensatory nature, which must have some link with the vehicles using the roads. The
regulatory and compensatory nature of the tax is that taxing power should be used to levy taxes on
motor vehicles, which use the roads in the State or are kept for use thereon.
 Later in, International Tourist Corporation v. State of Haryana21, The State of Haryana levied a tax
on transporters plying motor vehicles between Delhi and Jammu & Kashmir. They use national
highway, pass through Haryana without picking up or setting down any passenger in the State.
The responsibility for constructing and maintaining of national highways rests on the Centre. It

19
G.K. Krishnan, 1975 AIR SC 583.
20
Bolani Iron Ores v. State of Orissa, 1975 AIR SC 17 (Supreme Court of India).
21
International Tourist Corporation v. State of Haryana, 1981 AIR SC 774 (Supreme Court of India).
was therefore argued by the transporters that the tax could hardly be regarded as compensatory,
but the Court rejected the contention.
 CONCLUSION

 The position as it stands today is not as vague as it was during the time of the Atiabari and the
Automobile cases. We must settle the ratio in these two landmark cases. From the discussion of
the Supreme Court in the said cases, few important principles were established first, that
restrictions operate on freedom of trade and commerce remotely and indirectly do not violate
Article 301 and need not be justified under the provisions of Article 304 (b).

 Second, that measures which operate directly and immediately on the freedom of trade,
commerce and intercourse may be violative of Article 301, unless it is not violative of the
reasonableness aspect guaranteed by Article 304 (b).

 Last important principal was that those measures having direct and immediate effect will come
under the restrictive provisions of Article 301 provided that these measures are compensatory or
are regulatory. To reconcile the freedom of trade and commerce and the power of taxation, the
Supreme Court has developed the concept of regulatory and compensatory tax. This means that
Article 301 cannot stand in a way of a regulatory or compensatory tax. The concept of regulatory
and compensatory tax has been applied by Indian Courts mainly to the State taxation under
Entries 56 and 57 of List II. The need for imposing this type of a tax is to impose a levy on trade
and commerce at least to the extent of making it pay for the facilities provided by the State, for
example, a road network and other infrastructural facilities which are necessary for free flow of
trade and commerce. The reason for this is that taxes of this nature facilitate rather than hamper
the flow of trade and commerce.

 It can be thus stated that the freedom of trade and commerce can be infringed in any manner
except for the situations when regulatory and compensatory measures are imposed. Thus, there is
a violation of this freedom only when a legislative or executive act operates to hamper trade,
commerce and intercourse, directly and immediately, different from creating some indirect or
inconsequential impediment that may be regarded as remote. Only taxes that directly and
immediately restrict trade will be in contravention to Article 301. When a tax is imposed solely
on the basis that goods are carried or are transported, it would affect the freedom of trade and
commerce, or when a tax that discriminates between goods of one State and another is imposed,
it would violate Article 301. Further it has to be concluded that only those taxes that directly
hamper the trade or business will be void, otherwise no tax can be cancelled by declaring it as
being violative of Article 301. Laws, which are purely regulatory and compensatory in nature,
are not violative of the freedom so guaranteed. Researcher will conclude with last that we need a
strong and powerful constitutional authority to run the trade and commerce freely throughout the
territory of India under Article 307.