An Analysis of Section 7 of the Kerala General Sales Tax Act, 1963: The Compounding Scheme

A Comprehensive Analysis of Section 7 of the Kerala General Sales Tax Act, 1963: The Compounding Scheme for Tax Payment

Introduction

Section 7 of the Kerala General Sales Tax Act, 1963 (hereinafter "KGST Act") provided a significant alternative mechanism for the payment of sales tax, commonly referred to as the compounding scheme. This provision allowed eligible dealers, under specified conditions, to opt for payment of tax at a compounded rate instead of undergoing the regular assessment process based on their taxable turnover as envisaged under Section 5 or Section 5A of the KGST Act. The primary objective of this scheme was to simplify tax compliance for certain categories of dealers and to ensure administrative convenience for the revenue authorities. This article undertakes a detailed analysis of Section 7, exploring its nature, key features, application to different classes of dealers, and its interpretation by the judiciary, drawing extensively from the provided reference materials and relevant legal principles of India.

The Nature and Purpose of Compounding under Section 7

The scheme of compounding under Section 7 of the KGST Act was essentially an alternative method of taxation.[6] It began with a non-obstante clause, "Notwithstanding anything contained in sub-section (1) of section 5," thereby giving the provisions of Section 7 an overriding effect over the regular levy of tax on the sale or purchase of goods based on taxable turnover as stipulated in Section 5(1).[6, 14] The Supreme Court, in Bhima Jewellery v. Assistant Commissioner (Assessment), Kerala And Another, characterized the option of composition of tax as being "like a bilateral agreement between the parties with an object to dispense with the rigors of regular assessment."[6]

The Kerala High Court in Builders Association Of India And Others v. State Of Kerala And Another (1995) elaborated on this, stating that under the compounding scheme, "assessment is avoided and collection of tax is made easy by resorting to compounding. It is a matter of adjustment of rights and liabilities of both sides."[10] This underscores the dual benefit: simplification for the taxpayer and streamlined collection for the revenue.

Key Features and Application of Section 7

Section 7 of the KGST Act was not a uniform provision; its application and the method of calculating the compounded tax varied depending on the category of the dealer and the specific sub-section applicable to them. Several key features were common to the scheme:

  • Optional Scheme: The foremost feature was its optional nature. A dealer had to exercise an option to pay tax under this section.[6, 16] Once this option was exercised and accepted by the authorities, it generally became binding.[6]
  • Specific Categories of Dealers: The compounding facility was extended to various classes of dealers over time through different sub-sections. Examples include:
    • Dealers in gold or silver ornaments or wares (Section 7(1)(a)).[6, 14]
    • Contractors engaged in civil works of construction (Section 7(7), (7A)).[9]
    • Bar attached hotels (Section 7 as amended, relevant to cases like M/S. Hotel Asoka[15] and STATE OF KERALA v. M/S.JAWAHAR TOURIST HOME[13]).
    • Dealers with crushing units (Section 7(1)(b) as per Varkisons Engineers[16]).
  • Basis of Compounded Tax: The methodology for determining the compounded tax amount differed:
    • For dealers in gold or silver ornaments, Section 7(1)(a) (as quoted in Bhima Jewellery[6, 14] for the relevant assessment year) stipulated payment of tax at "one hundred and thirty per cent of the tax payable by him as conceded in the return or accounts or the tax paid for the previous consecutive three years whichever is higher."
    • For works contractors under Section 7(7), tax could be paid "at the rate of two per cent on the whole amount of contract."[9] The Kerala High Court in Builders Association Of India (1995) clarified that this "whole amount" was distinct from "taxable turnover" under Section 5, which allowed for deductions.[10]
    • For bar attached hotels, the formula often involved a percentage of the purchase price of liquor, or was linked to the highest tax paid in prior years, with "whichever is higher" clauses causing considerable litigation (e.g., Section 7(a) and (b) discussed in M/S. Hotel Asoka[15, 20] and M/S. Hotel Alakananda[17]).
  • Procedural Aspects: The KGST Rules, particularly Rule 30, laid down the procedure for opting into the scheme. This typically involved filing an application (e.g., Form 21) by a specified date, followed by the assessing authority granting permission (e.g., Form 21A or Form 22).[16, 18] The tax was often payable in monthly instalments.[16] The Kerala High Court in STATE OF KERALA v. M/S.JAWAHAR TOURIST HOME, citing CTO v. Hotel Breezeland, noted that the permission (Form 22) could be provisional, and an assessment was contemplated even under the compounding scheme, as liability could depend on factors determined at year-end.[13, 22]

Judicial Interpretation of Section 7

The application and interpretation of Section 7 have been the subject of numerous judicial pronouncements, clarifying its scope and resolving ambiguities.

Effect of Opting for Compounding

A crucial aspect clarified by the Supreme Court in Bhima Jewellery (2014)[6, 14, 19] concerned the dealer's liability for other taxes. Section 5-D of the KGST Act provided for an additional sales tax on dealers liable to pay tax under Sections 5 and 5A. The Court held that a dealer who opts for payment of tax at compounded rates under Section 7 is *not* being taxed under Section 5 or Section 5A. Therefore, such a dealer would not be liable to pay additional tax under Section 5-D. The Court reasoned:

"In the instant case, the dealer is not being taxed under section 5 or section 5-a of the kgst act but is paying tax at the compounded rate as envisaged in section 7 of the kgst act and therefore will not be liable to pay additional tax under the amended provision of the KGST Act."[6]

Furthermore, for works contractors opting for compounding, the Kerala High Court in Builders Association Of India (1995) held that once a person compounds to pay tax, "the whole amount has to be taken into account for the purpose of prescribing the rate of tax," and there is "no question of making allowance for sales taking place in the course of inter-State trade, for declared goods and for labour charges," unlike under the normal levy provisions.[10]

Determination of "Highest Tax Payable" or Base for Compounding

A contentious issue, particularly for bar hotels, was the interpretation of phrases like "highest turnover tax payable by an assessee as conceded in the return or accounts" or similar clauses used to determine the base for compounding. The question often arose whether this referred only to the tax as per the dealer's returns or could include amounts determined upon assessment by the officer, especially if prior years' assessments were revised upwards.

In STATE OF KERALA v. M/S.JAWAHAR TOURIST HOME (2020), the Kerala High Court, following its earlier decision in Kalika Hotel and Bar, Amballur (M/s.) V. State of Kerala (2012 (3) KHC 85)[21], addressed this. The Court noted that for the relevant years, Section 7 required determination based on "the purchase value of liquor for the subject year or the return."[13] The Kalika Hotel case distinguished State of Kerala V. Malabar Ornaments (P) Ltd. (2011 KHC 199) based on differences in the wording of the applicable provisions.[13, 21] The Kalika Hotel decision suggested that "highest turnover tax payable by an assessee as conceded in the return or accounts" does not contemplate assessed tax.[21] However, the broader discussion in Jawahar Tourist Home also pointed out that the tax payable in prior years could be modified in an assessment, and the purchase value for the current year is determined post-year-end, implying that the initial permission for compounding is provisional and subject to final assessment even within the compounding scheme.[13, 22]

Amendments to Section 7 and Retrospectivity

The provisions of Section 7 were amended several times, leading to disputes, particularly concerning retrospective application.

In Varkisons Engineers v. State Of Kerala And Another (2009), the Supreme Court considered a case where a dealer had opted for compounding under Section 7, and permission was granted for the full financial year. Subsequently, the Finance Act, 2001, enhanced the rate per machine with effect from a mid-year date (23-7-2001). The Court held that since the entire exercise of opting for the alternate method of taxation and quantification of demand stood concluded on the date permission was granted (9-4-2001 for the financial year 2001-2002), the enhanced rate could not be applied to this concluded arrangement.[16]

Conversely, in cases like M/S. Hotel Asoka v. The Commercial Tax Officer-1 (2007)[15, 20] and M/S. Hotel Alakananda v. The Commercial Tax Officer S (2018)[17], the Kerala High Court dealt with amendments to Section 7(a) and (b) for bar hotels, which were introduced with retrospective effect. These amendments often changed the basis for calculating compounded tax, for instance, by introducing or modifying a "whichever is higher" clause. The courts had to determine if these retrospective amendments could apply to dealers who had already opted for compounding under the unamended provisions for the assessment year. The High Court in Hotel Asoka upheld the application of such amended provisions, even if the option was exercised before the amendment. The interpretation of "whichever is higher" linking clauses (a) and (b) of Section 7 (as amended for bar hotels) was also a point of contention, with arguments made that they should be read disjunctively.[20]

Binding Nature of Option and Procedural Compliance

The Supreme Court in Bhima Jewellery affirmed that once a dealer's option for compounded payment is exercised and accepted, "it is no longer open to the dealer to request for a regular assessment as envisaged under section 5 or section 5-a of the kgst act."[6]

The Kerala High Court in State Of Kerala v. Sri. T.S Kalyanaraman, Kalyan Jewellers (2009) dealt with a situation where a dealer applied for compounding, and though the Assessing Officer did not formally pass orders or issue Form 21A/22, the assessee remitted tax as per the compounding application throughout the year without objection from the AO. When the AO later found a deficiency in the compounded tax calculation, the assessee sought regular assessment. The Court found that the assessee had acted upon the compounding application, and the Tribunal's decision to allow the assessee to opt out was questioned, implying that the conduct of the parties could affirm the compounding arrangement.[18]

Section 7 in Relation to Other KGST Provisions

The fundamental relationship of Section 7 with Sections 5 and 5A of the KGST Act is that it provides an alternative scheme of tax payment, not an additional one. Section 5 is the primary charging section for levy of tax on sales or purchases, and Section 5A deals with purchase tax. Section 7, by its non-obstante clause, carves out an exception for dealers who opt into its framework. As established in Bhima Jewellery, choosing Section 7 means the dealer is not taxed under Section 5 or 5A for the transactions covered by the compounding scheme.[6] This has direct implications for the applicability of other provisions, such as Section 5-D (Additional Sales Tax), which are predicated on liability under Sections 5 or 5A.[6, 14]

Challenges and Complexities

Despite its aim for simplification, Section 7 presented several challenges:

  • Interpretation of Terms: Phrases like "tax payable by him as conceded in the return or accounts"[6, 21] versus "tax assessed" or "tax paid" for previous years became focal points of dispute, requiring judicial clarification on whether the base for compounding should consider only the dealer's declared figures or the finally determined tax liability for prior periods.
  • Retrospective Amendments: Frequent amendments, sometimes with retrospective effect, created uncertainty for dealers who had already opted into the scheme based on the then-existing provisions. This raised questions about the fairness and predictability of the compounding "agreement."[16, 17]
  • Balance Between "Bilateral Agreement" and Statutory Power: While termed "like a bilateral agreement,"[6] the scheme was ultimately governed by statute, which could be amended by the legislature. Reconciling the legitimate expectations of dealers under an accepted compounding arrangement with the legislative power to amend tax laws retrospectively remained a complex area.

The general principles of statutory interpretation, including the limits of rule-making authority as discussed in cases like Sales Tax Officer Ponkunnam And Another v. K.I Abraham[1] (though under the Central Sales Tax Act), would also be relevant in ensuring that rules framed under the KGST Act to implement Section 7 do not go beyond the powers conferred by the section itself.

Conclusion

Section 7 of the Kerala General Sales Tax Act, 1963, served as a vital mechanism offering an alternative, simplified route for tax payment for specified categories of dealers. It aimed to reduce the complexities of regular assessment procedures, benefiting both taxpayers and the administration. However, its application was fraught with interpretive challenges, particularly concerning the determination of the compounded amount, the effect of amendments (especially retrospective ones), and the precise nature of the "option" exercised by the dealer. The judiciary, through numerous pronouncements, played a crucial role in shaping the understanding and application of this provision, striving to balance the intent of simplification with the nuances of tax law and legislative changes.

With the advent of the Goods and Services Tax (GST) regime, the KGST Act has been largely repealed. However, legacy issues pertaining to assessments, appeals, and revisions under the KGST Act, including those related to Section 7, may continue to arise, as indicated by cases dealing with savings clauses like Section 174 of the Kerala State Goods and Services Tax (KSGST) Act.[7, 8] The principles evolved in the interpretation of Section 7 thus retain relevance for resolving such pending matters and offer insights into the functioning and challenges of tax compounding schemes in general.

References