Cesses are either economically inefficient or are not used for their earmarked purpose. Is it appropriate then for governments to continue with a rampant imposition of cesses?
Just as we are still grappling with the introduction of the Swachh Bharat Cess, the Finance Minister has announced a slew of measures involving cesses in his budget speech. He has proposed to introduce two new cesses, rename and increase the rate of one, change the purpose of an existing one and abolish 13 others. Reading the proposals more closely raises some very pertinent questions on the propriety of cesses as a means of raising revenue.
Constitutional scheme on cesses
The Constitution recognizes the government’s power to raise revenues by imposing cesses. A cess is typically a tax for a specific purpose. As per Article 270 of the Constitution, cesses imposed by the Parliament for earmarked purposes need not be shared with state governments. The proceeds are retained exclusively with the Union government, which should ideally be used for their stated purpose.
Krishi Kalyan Cess
The Krishi Kalyan Cess is proposed to be imposed at 0.5% on all taxable services and the proceeds are to be used for financing initiatives relating to improvement of agriculture and welfare of farmers. The cess is to come into force from June 1, 2016.
On account of this cess, service tax will stand revised to 15% from 14.5%; a second increase of 0.5% in eight months, since the imposition of the Swachh Bharat Cess. While the base of both cesses remains taxable services, there is one significant difference. Krishi Kalyan Cess will be eligible for an input tax credit while Swachh Bharat Cess has not been.
By extending an input tax credit, a person gets the benefit of cess paid on any input services. Meaning, any cess paid on taxable services used in the process of creating any goods or services can be used to set off one’s outstanding liability. This lowers the effective rate of the cess. In terms of the revenues, the impact is staggering. While it is estimated that Krishi Kalyan Cess will help collect Rs. 5,000 crores, the Swacch Bharat Cess will garner Rs. 10,000 crores.
While the availability of input tax credit is positive, no explanation has been given to substantiate the differential treatment of Krishi Kalyan Cess and Swachh Bharat Cess on this account. It just looks like a number game then.
The Finance Minister has also announced an Infrastructure Cess in order to curb pollution and traffic. The cess ranges from 1% to 4% depending on the car or vehicle being purchased. This cess will not be eligible for an input credit. Some vehicles are eligible for an exemption, such as vehicles registered for use solely as taxis or ambulances, electrically operated vehicles, hydrogen vehicles based on fuel cell technology, cars for physically handicapped persons and three wheeled vehicles.
The use of cesses for checking pollution is not new. Most recently, in October, 2015, the Supreme Court [in M.C. Mehta v. Union of India (2015 (11) SCALE 565)] directed the Delhi government to levy a cess by the name of environment compensation charge to check pollution by commercial traffic travelling from North India towards Jaipur and onwards via Delhi. The proceeds were to be earmarked for augmenting public transport and improving roads, particularly for most vulnerable users, that is, cyclists and pedestrians.
The Supreme Court thought it fit to exercise extreme caution while levying the cess – it was to be collected on an experimental basis (November 1, 2015 to February 29, 2016) and if continued, accounts were to be submitted to the Court on a quarterly basis.
We can only hope that the government takes a cue from the Supreme Court’s approach.
Clean environment cess and road cess
The Clean Energy Cess has been rebranded as the Clean Environment Cess. The cess is levied on coal, lignite and peat and its rate has been simultaneously increased from Rs. 200 per tonne to INR 400 per tonne. It is not clear whether the rebranding exercise indicates a change of purpose too.
On the other hand, the government has confirmed that the Central Road Fund Act, 2000 will be amended to provide a formula for redistribution of cess funds for different purposes. The Central Road Fund Act, 2000 imposes road cess, commonly known as the excise and customs duty on petrol and high speed diesel.
While technically it is permissible to introduce an amendment, it ought to be done transparently and applied prospectively. Otherwise, proceeds would not have been applied for their original purpose.
Abolition of thirteen cesses
The Finance Minister’s justification to abolish 13 cesses which yield less than Rs. 50 crores as annual revenue is to reduce multiplicity of taxes, associated cascading and cost of collection. This is a welcome step. The economic efficiency reasoning is in line with the canon of economy propounded by Adam Smith. Basically, the canon of economy states that the administrative cost incurred in collecting taxes should not exceed the revenue generated from the levy of the tax.
However, this bears out the larger issue at hand; a number of cess statutes have not worked well. Even in 2006, The Cess Laws (Repealing and Amending) Act, 2006 repealed four statutes based on a similar justification.
The curious case of cesses
The government has tried to allay fears by saying that the cesses will be subsumed in the Goods and Services Tax, once introduced. Even if this were true, this would not hamper cesses being imposed as part of the direct tax regime.
The Sarkaria Commission remarked way back in 1988 that the application of cesses must be for limited duration. In practice though, cesses are in the form of non-lapsable funds with little or no transparency on use of proceeds. CAG reports have brought to light the consistent short transfer of cess funds in many instances including Road Cess.
Based on the available precedents, the curious case of cesses can be summed thus: either they are economically inefficient or they are not being used for their earmarked purpose. Then, is it appropriate for governments to continue with a rampant imposition of cesses?
Ashrita Prasad Kotha is an Assistant Professor & Assistant Director, Centre for Comparative and International Taxation, Jindal Global Law School.