Whether Royalty is a Tax or a Fee for Service? A 9-Judge Constitution Bench Answers this Question in a Landmark Ruling, Applicable Retrospectively

Introduction

The Supreme Court’s landmark judgment in Mineral Area Development Authority & Anr. v. M/s Steel Authority of India & Anr. Etc.[i], followed by a subsequent ruling[ii] on the judgment’s applicability, addressed the critical issue of whether royalties imposed on minerals mined within states should be classified as taxes. This decision is pivotal for understanding the taxation powers under the Constitution of India ('Constitution'), particularly in balancing the authority between state governments and the Central government in regulating mineral resources.

This case revolved around whether the Mineral Area Development Authority (‘MADA’) had the legal authority to levy a tax on mining activities conducted by the Steel Authority of India (‘SAIL’) without infringing on the regulatory powers reserved for the Central government under the Mines and Minerals (Development and Regulation) Act, 1957 (‘MMDR Act’). The Constitution Bench’s ruling has significant implications for the steel and mining industries and sets a precedent for interpreting taxation and royalty provisions across India.

Brief Facts

• The dispute arose when MADA imposed a levy on SAIL for mining operations within its jurisdiction under the Bihar Mineral Area Development Authority Act, 1986. SAIL challenged this levy, arguing that it amounted to an unconstitutional encroachment on the Union’s authority over minerals under the MMDR Act.

• SAIL contended that the levy imposed by MADA was not merely a fee for services rendered but constituted an unauthorized tax. SAIL argued that the MMDR Act and the rules framed thereunder fully occupied the field of regulating and taxing mining activities, leaving no room for additional levies by state authorities like MADA.

• The matter reached the Patna High Court, where complete reliance was placed on the decision in India Cement Ltd. v. State of Tamil Nadu[iii]. Royalty was held to constitute a tax, and the State legislatures were held to lack the competence to impose any additional levies under entries 23 and 50 of List II of sch. VII of the Constitution.

• This decision was challenged before the Supreme Court, whereby a 3-Judge bench observed conflicting interpretations in previous judgments, including India Cement Ltd. (supra) and State of West Bengal v. Kesoram Industries Ltd.[iv], necessitating a larger bench to resolve the divergence in judicial opinion, leading to a significant constitutional debate on the delineation of taxation powers concerning mineral resources.

Held

• By an 8:1 majority, the Supreme Court reversed the High Court’s decision, holding that States have the power to levy taxes on mineral rights under entry 50 of List II. The Court extensively analysed whether MADA’s levy was a tax or a fee. It concluded that the levy was a tax, not a fee because it lacked a clear and direct link to any specific service provided by MADA to SAIL. The Court held that royalties are distinct from taxes, emphasizing that a fee requires a quid pro quo – a direct correlation between the levy and the service rendered – which was absent in this case.

• The Court applied the ‘occupied field doctrine’, stating that the MMDR Act does not preclude the State’s power to tax mineral activities within their territories. The doctrine of occupied fields prevents state legislation from encroaching on areas fully occupied by central laws. The Court held that while the MMDR Act is comprehensive in regulating mining, any state legislation or authority seeking to impose levies must operate within the boundaries set by the central Act.

• The Court discussed the principles of federalism, noting that both the Union and State legislatures have distinct yet sometimes overlapping powers. It emphasized that the Constitution allows states to impose taxes on mineral rights under entry 50 of List II, subject to limitations imposed by Parliament. Since the MMDR Act did not expressly limit this taxing power, states retained the right to levy such taxes.

• Referring to as. 246 and 265 of the Constitution, which outline the distribution of legislative powers and the regulation of taxation, the Court held that MADA’s imposition of the tax fell within the scope of state legislative competence. Hence, it affirmed the levy’s constitutional validity as a tax under entry 50.

• The judgment overruled earlier decisions, including India Cement Ltd. (supra), which had incorrectly categorized royalty as a tax and constrained state powers. The Court realigned its position with the broader constitutional scheme, affirming that royalties, distinct from taxes, are payments for extraction rights, while taxes on mineral rights can coexist under specific conditions.

Dissenting Opinion

The dissenting opinion argued against the majority’s broad interpretation of state powers to levy taxes on mineral rights and held that royalty is a tax. The dissenting judge emphasized that the MMDR Act fully occupied the field of mining regulation and taxation, leaving no room for additional state-imposed taxes. Allowing MADA’s levy, according to the dissent, would disrupt the uniform regulatory framework established by Parliament, contrary to the principles of centralized control over mineral development. The dissent highlighted that entry 50 of List II is subject to ‘any limitations imposed by Parliament by law relating to mineral development’, which, in the judge’s view, included the MMDR Act. The dissent argued that the Act’s comprehensive nature limits state power to levy taxes on minerals, thereby making MADA’s levy unconstitutional. It emphasized that the occupied filed doctrine should apply strictly in this context and concluded that the majority’s decision diluted this principle, undermining the Act’s intended uniformity.

Prospective Overruling

Following the main judgment, the Court considered whether to apply the decision retrospectively or prospectively. Arguments were made for prospective application due to reliance on the earlier India Cement Ltd. (supra) judgment, which had been in effect for over three decades. However, the Supreme Court rejected the plea for prospective overruling. Instead, it allowed states to impose taxes retrospectively under specific conditions, such as staggering payments over a 12-year period starting from April 2026 and waiving penalties on demands made before July 2024. According to the Court, this approach aimed to balance the financial interests of both states and affected industries.

Our Analysis

The Supreme Court’s decision is a landmark judgment that clarifies the delineation of taxation powers between the Central and State governments concerning mineral resources. By emphasizing federalism and legislative competence, the Court reinforced states’ rights to tax mineral rights while maintaining the supremacy of central regulation under the MMDR Act. This ruling overturned a three-decade-old precedent in India Cement Ltd. (supra) and related cases, significantly shifting the judicial approach by clarifying the distinction between taxes and royalties.

The judgment strengthens the principle of federalism by clearly defining the boundaries of central and state powers. It acknowledges the state’s authority to tax mineral rights under specific constitutional entries, even when central legislation occupies the regulatory field. This interpretation aligns with the broader trend of empowering states within the Indian federal framework, allowing for a more nuanced and collaborative approach to governance.

While the majority decision clarified that states could levy taxes but not fees disguised as taxes unless there is a clear service rendered, the dissenting opinion pointed out the need for a consistent central authority in sectors like mineral development. The irony of the Constitution Bench’s decision is that, despite resolving divergent views on taxation and state powers, it has brought the discussion full circle. Although the judgment provides substantial material for legal analysis, particularly regarding constitutional interpretations, it ultimately leads us back to the starting point with yet another set of divergent views, reflecting the complexity and cyclical nature of these legal debates.

End Notes

[i] [2024] 164 taxmann.com 806 (SC), dated: 25.07.2024.

[ii] [2024] 165 taxmann.com 477 (SC), dated: 14.08.2024.

[iii] (1990) 1 SCC 12.

[iv] (2004) 10 SCC 201.

Authored by Srishty Jaura, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.