Karnataka HC: MAT On SEZs Constitutional!

In 2006, in Kamal Nath's words – 'the SEZ policy (SEZ Act 2005 & SEZ Rules 2006) is meant mainly to provide a "one stop shop" doing away with multiplicity of controls and clearances, along with fiscal concessions and simplified procedures. That means one of 3 things that made these economic zones special was fiscal incentives. Yet the Karnataka High Court says the recent imposition of Minimum Alternate Tax on SEZs is neither a breach of promise nor a violation of the doctrine of legitimate expectation. By upholding the constitutional validity of tax levies on SEZs, the Karnataka High Court has become the first high court to rule on this rather contentious issue that saw a spate of appeals in the last two years. Payaswini Upadhyay reports on the ruling and its impact

It's a violation of the doctrine of promissory estoppel and doctrine of legitimate expectations. That's the argument software company Mindtree and several others made when they challenged the levy of 18.5% Minimum Alternate Tax and Dividend Distribution Tax on Special Economic Zones. These taxes were imposed by Budget 2011- 5 years after the SEZ Act promised companies in special economic zones tax relief on profits and dividends. Though the SEZ Act and the pursuant amendments to the Income Tax Act did not specify a time limit to these tax incentives, it was well understood that the SEZ policy was predicated on tax relief and that's what made these economic zones special. Hence when faced with a sudden change in policy in 2011, the companies argued that it made investments expecting these incentives to continue and that the withdrawal of these exemptions is abrupt, arbitrary and unfair. Bomi F. Daruwala
Partner, Vaish Associates
"The way the Doctrine of Promissory Estoppels works is that if a promise is made by a government agency and a person on the belief that this promise will be implemented, he has altered his position, then in that particular case if the government agency goes back on his promise, the person whose position has been altered can go to the court and say that the intended benefit should be made available to him as promised." Historically, courts have upheld that a legislation will override the principle of promissory estoppel. But the same has not always been applied to executive action. In 1978 in the Motilal Padampat Sugar Mills case, the Supreme Court upheld the estoppels principle against the UP government that withdrew the promised sales tax exemption to new industrial units. Nishith Desai
Founder, Nishith Desai Associates
"If you ask me, from a legal standpoint, at least as the law stands by and large, is that you cannot invoke theory of promissory estoppel against the legislative action. Legislature can do anything except it can’t be violative of constitutional provisions. But this action can lie against the executive." Dinesh Vyas
Senior Advocate
"In the growing business environment where the government leads the industry to go in a certain direction, in these areas of tax legislation, one has to have a fresh look. So if one, based on the assurances or promises given by the parliament, the taxpayer has made certain sacrifices or made huge investments acting on that assurance, then they should not be hit by any law which is thereafter passed by the parliament. So it is here that a fresh look is necessary." A fresh look that Mindtree did not get the benefit of. A single judge bench of the Karnataka High Court ruled that the estoppel promissory cannot be used against legislative action. It held MAT and DDT as constitutional on 3 grounds- first that every tax exemption and incentive should have a sunset clause and by withdrawing the exemption to SEZs, the government is correcting the lapse on its part. Second, the withdrawal of the exemption removes the inequality between SEZ and other companies. And third, the exemptions provided to SEZ companies resulted in erosion of tax base. Dinesh Vyas
Senior Advocate
"First of all, it's not a well settled principle that every relief has to have a sunset clause. There is no such legal or parliamentary compulsion. There are several provisions in the Act – take for instance investment allowance – there never was a sunset clause. It was intended for the development of the entire industry. And it was regarded, at that time, a fundamental feature of the Income Tax Act. So it is wrong to say that every exemption should have a sunset clause. Second, the question of discrimination. Here’s not a case where those who have not set up the SEZs are complaining against the persons who have set up SEZs. Frankly, discrimination point is wholly irrelevant. And thirdly, on erosion of the tax base- when parliament introduced this exemption, it did it with its eyes open." Nishith Desai
Founder, Nishith Desai Associates
"Theory of legitimate expectation is that where a fundamental legitimate expectation among the member of the society or vis—vis the government – then that can possible be challenged under Article 14 because ots something like principles of natural justice. For eg, right to be heard before any case is decided, that is fundamental principle fo natural law. Similarly legitimate expectation has also been construed as fundamental principle of natural law. In fact, some of the decisions internationally have gone on to say that if it’s a change in statute, at least you should have a consultative process if its suddenly adverse to the promise you made by way of statute. Unfortunately, this judgment does not discuss the theory of legitimate expectation especially vis-à-vis Article 14." The amendments introduced in the Finance Act have adversely affected 584 SEZ developers. And so, in the last two years, several companies have contested the constitutional validity of MAT and DDT on SEZs in Bombay, Madras, Andhra Pradesh and Gujarat HC. For instance, two Adani Group companies had moved the Gujarat HC in May 2011. Besides the argument of violation of estoppels and reasonable expectation principle, Adani argued in its petition that the Finance Act cannot amend the SEZ Act and that any imposition of tax would have to be done by amending the SEZ Act itself. Bomi F. Daruwala
Partner, Vaish Associates
"I think that this a weak argument. Essentially, it’s the law of the Parliament. The SEZ Act was the one which brought in the relevant provisions relating to SEZ units in the Income Tax Act. And now the Finance Act is altering these provisions in the Income Tax Act and the SEZ Act. So it’s a legislation passed by the Parliament. And that argument, I don’t think will hold water." The decision by the Karnataka HC is by a single judge bench and so experts say it would have only a persuasive effect on other pending cases in various high courts. Dinesh Vyas
Senior Advocate
"This ruling by the Karnataka High Court is delivered by a Single Judge. It is not a judgment of a Division bench which is always constituted by two judges of a court. Always in the hierarchal system, if suppose this matter goes to the Bombay or Gujarat High Court, where it will definitely be heard by the Division Bench - none of these Benches will take this decision as a binding decision. Apart from that, as I have said earlier, in certain areas, there is a flaw in the reasoning. So for me, it’s a fresh battle." 379 notified SEZs, 110 operational with exports of over Rs 2 lakh crore and thousands of companies set up in these zones- all of them would be closely watching the decision from other High Courts. In Mumbai, Payaswini Upadhyay