The Supreme Court of India, in a significant ruling on inter-state trade, has quashed a notification issued by the Government of Rajasthan that granted a full exemption from Value Added Tax (VAT) to locally manufactured asbestos cement products. A bench comprising Justice B.V. Nagarathna and Justice K.V. Viswanathan held that the exemption, which was not extended to similar goods imported from other states, was discriminatory and violated Article 304(a) of the Constitution.
The Court ruled that tax incentives favouring local manufacturers over those from other states must be supported by clear, justifiable reasons stated within the notification itself and cannot be rationalized later through affidavits. The judgment reinforces the constitutional mandate for a unified economic market across India, free from protectionist fiscal barriers erected by individual states.
Background of the Case
The appeals were filed by M/s. U.P. Asbestos Limited and M/s. Everest Industries Limited, companies that manufacture asbestos cement products outside Rajasthan but sell them within the state through registered sales depots.
The dispute centred on Notification No. S.O.377, dated March 9, 2007, issued under the Rajasthan Value Added Tax Act, 2003. This notification exempted from tax the sale of asbestos cement sheets and bricks manufactured within Rajasthan, provided they contained 25% or more fly ash by weight. The benefit was limited to dealers who had commenced commercial production in the state by December 31, 2006, and was initially available until January 23, 2010.
This policy was a continuation of earlier exemptions dating back to January 24, 2000, under the preceding Rajasthan Sales Tax Act, 1994, which were progressively extended. The appellants challenged the 2007 notification before the Rajasthan High Court, arguing it created an unconstitutional discrimination against their products.
The High Court dismissed their petitions, relying heavily on the Supreme Court’s 1989 judgment in Video Electronics Pvt. Ltd. vs. State of Punjab, which had upheld certain tax incentives for local industries under specific circumstances. Aggrieved by the High Court’s decision, the companies appealed to the Supreme Court.
Arguments of the Parties
Appellants’ Submissions:
- Senior Counsel Mr. Nikhil Goel and Advocate Ms. Kavita Jha, representing the appellants, argued that the notification was “discriminatory in nature and falls foul of Article 304(a) of the Constitution.” They contended it created an unfair advantage for local manufacturers, thereby impeding the free movement of trade and commerce guaranteed under Article 301.
- They pointed out that the supposed justification—to encourage the use of fly ash available in Rajasthan—was not mandated by the notification itself, as local manufacturers could source fly ash from anywhere.
- The appellants argued that the reliance on the Video Electronics case was misplaced. That case, they submitted, involved a carefully structured incentive for a specific class of new industrial units for a limited period to develop a backward or disturbed state. In contrast, the Rajasthan exemption had been extended for over a decade to all manufacturers, old and new.
- Citing the Constitution Bench decision in Mohinder Singh Gill vs. Chief Election Commissioner, they asserted that the validity of a public order must be judged by the reasons mentioned in the order itself and “cannot be supplemented by fresh reasons in the shape of an affidavit or otherwise.”
Respondent’s Submissions (State of Rajasthan):
- Senior Counsel Dr. Manish Singhvi, appearing for the State, defended the notification as a valid exercise of its sovereign power to promote industrial growth. He argued that it was a form of ‘differentiation’, not ‘discrimination’, a principle endorsed by the nine-judge bench in Jindal Stainless Ltd. vs. State of Haryana.
- The State contended that the policy was designed to attract investment in a sector where no manufacturing units previously existed in Rajasthan and to promote the use of fly ash, an abundant local raw material with environmental benefits.
- Dr. Singhvi maintained that the exemption fell within the “exceptional category” carved out in Video Electronics, as it was for a specified class of goods and for a limited period, aimed at achieving legitimate economic objectives. He stated that without such incentives, “no asbestos sheet industry would have come to the State of Rajasthan.”
Court’s Analysis and Reasoning
The Supreme Court undertook a comprehensive review of the jurisprudence on Part XIII of the Constitution, which governs trade, commerce, and intercourse within India.
The bench held that the primary test was whether the impugned notification could be justified under the limited exception established in the Video Electronics case, as interpreted by the nine-judge bench in Jindal Stainless Ltd. The criteria for a permissible differentiation include incentives being granted to a specified class of dealers, for a limited time, in a non-hostile fashion, and with the objective of developing economically backward areas.
Applying this test, the Court found the Rajasthan notification wanting. Justice Nagarathna, writing for the bench, observed that the notification’s only stated reason was that it was “expedient in the public interest so to do,” which was deemed insufficient. The Court held, “In the absence of any such explanation, we cannot, but conclude, that the impugned notification is bereft of any reason or justification.”
The Court unequivocally rejected the State’s attempt to provide justifications through its counter-affidavit. Upholding the Mohinder Singh Gill principle, the judgment stated, “Public orders, publicly made, in exercise of a statutory authority cannot be construed in the light of explanations subsequently given by the officer making the order… [They] must be construed objectively with reference to the language used in the order itself.”
Furthermore, the Court identified a fatal flaw in the notification’s design. If the objective was genuinely to promote the use of fly ash from Rajasthan, the exemption should have been linked to the source of the raw material, not the location of the manufacturing unit. The Court noted, “If the notification had prescribed a condition that fly ash sourced from State of Rajasthan and products sold in the State, irrespective of their place of manufacture would have the benefit such exemption, there would not have been any discrimination.”
The Court concluded that the case was squarely covered by its earlier decision in State of U.P. vs. Jaiprakash Associates Ltd., where a similar tax rebate for cement manufacturers using fly ash only within Uttar Pradesh was struck down as discriminatory.
The Final Decision
The Supreme Court allowed the appeals and quashed the Notification No. S.O.377 dated March 9, 2007, declaring it violative of Article 304(a) of the Constitution.
The bench directed that the matter be listed again for directions on the refund of the differential tax amount deposited by the appellants with the Court during the pendency of the litigation. The Court clarified that the appellants would be entitled to a refund with 6% annual interest, provided they had not collected the said amount from their customers.
