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South -Asian Journal of Multidisciplinary Studies: ISSN:2349-7858 Volume 2 Issue 4 (SJIF:2.
246)
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THE CONCEPT OF COMPENSATORY TAX & ITS RELEVANCE TO

FREEDOM OF TRADE AND COMMERCE UNDER INDIAN
CONSTITUTION
Raghuveer Singh Meena1
Introduction:
With Globalisation, industries require larger markets and as a country we cannot develop, if
we try and fragment every State and give liberty to them to levy entry taxes as per their
whims and fancies. Obviously States should not resort to such entry taxes for augmenting its
revenues.2 Further Central Government needs to ensure that they do not allow such
controversies to rope in the proposed Goods and Service Tax (GST) situation and they make
it clear while implementing Goods and Services Tax (GST) that States cannot levy any entry
tax on goods received within the State for consumption, use, or sale therein. In today’s world,
corporate world need clarity whether a particular levy is applicable or not so that they can
accordingly decide on their end pricing to the consumer. As a country, we cannot keep so
many Companies in doubt.3
Most of the States levy tax on activities related to trade and commerce and it is their major
revenue source. But it would be violative of Article 3014 under Indian Constitution if it would
impede the freedom of trade and commerce as it will affect the free flow of trade. As a result
States declare these types of taxes as compensatory and regulatory by saying that the
imposition of tax is for facilitating the trade and commerce by providing facilities like
maintenance of roads, traffic lights, etc.5
The main issue with which researcher is dealing in this research paper is that what should be
the criteria to decide whether the tax is compensatory or just for enhancing the revenue of
1
5 th year, B.A. LL.B. (Hons.) National Law School of India University, Bangalore
2
Kavita Choudhary et al, It's taxing time for regional parties, BUSINESS STANDARD (April 8, 2012),
available at http://www.business-standard.com/india/news/it//s-taxing-time-for-regional-parties/470491/ (Last
visited on April 8, 2012).
3
Special Correspondent, Entry tax worries business community, The Times of India (Mar 28, 2012), available at
http://www.indianexpress.com/news/entry-tax-worries-business-community/929824/ (Last visited on April 8,
2012).
4
Article 301, Indian Constitution, 1950.
5
Arvind P. Datar, COMMENTARY ON THE CONSTITUTION OF INDIA, Vol. 3, 1665 (2nd edn., 2007).
Published By :Universal Multidisciplinary Research Institute Pvt Ltd

South -Asian Journal of Multidisciplinary Studies: ISSN:2349-7858 Volume 2 Issue 4 (SJIF:2.246)
124
government. So, researcher has dealt with chapter XIII of Indian Constitution with several
cases of Supreme Court and analysed them to reach at a certain conclusion to abolish the
vagueness of the concept (upto certain level) of regulatory and compensatory tax.

125
Scope of Article 3016 of Indian Constitution:
One of the Constitutional aspirations is economic unity and the objective of Constitution is its
safe guarding its attainment and maintenance of that unity. As a result Part XIII (Trade,
commerce and intercourse within the territory of India) of the Constitution was created where
Article 301-305 have been created to ensure that State legislature subjected to regional and
local pulls and do not create trade barriers in future. These provisions deal with freedom of
trade, commerce and intercourse within the territory of India. The main provision is Article
301.7
The framers of our Constitution while framing Article 301 had before them the experience of
other Constitutions, particularly of the U.S. and Australian. They did not pursue the U.S.
model. They pursued the Australian model, and hence they introduced certain significant
changes. First change was that they replaced the words “among the States” and “absolutely
free” in section 92 of the Australian Constitution by the words “throughout the territory of
India” and “free” respectively in Article 301 but there is not absolute freedom for trade.
There are reasonable restrictions which can be used for emergencies, maintaining public
order, peace etc. The freedom provided by Article 301 is not confined only to inter-State but
also extends to intra-State trade and commerce.8
The general rule that trade, commerce and intercourse throughout the territory of India shall
be free has been enacted by Article 301. The freedom that has been provided by Article 301
may be defined as right to free movement of persons or things, tangible or intangible,
commercial or non-commercial, unobstructed by barriers, inter-State, i.e. trade and commerce
which overflows the boundary of one State and which extends to two or more States, or intra-
State, i.e. commerce which is confined within the territory of State or any other obstacles
operating as such barriers. All types of obstructions and impediments to the free flow or
movement of trade or non-commercial intercourse offend Article 301.9
The Constitution makers desired to promote free flow of trade and commerce in India
because they realised that economic unity and integration of the country provided the main
6
Article 301, THE CONSTITUTION OF INDIA, 1950.
7
P. M. Bakshi, THE CONSTITUTION OF INDIA, 273 (11th edn., 2011).
8
V. N. Shukla’s Constitution of India, 848 (Mahendra P. Singh ed., 11th edn., 2008).
9
H. M. Seervai, CONSTITUTIONAL LAW OF INDIA, Vol. 3, 2593 (4th edn., 2008).

126
sustaining force for the stability. The main object of this Article is to break down the border
barriers between the Constitutional States and to make the entire territory of the country as a
single unit with a view to encouraging trade and commerce in the country. 10
The freedom of trade and commerce in Article 301 is subject to the provisions in Articles
302-307. Parliament has been provided with the power to impose restrictions on the freedom
of trade, commerce and intercourse between one State and another or within any part of the
territory of India, but that must be in the public interest. 11 This power is also not absolute
because Parliament cannot make any law with respect to trade and commerce which provides
preference to one State over another, or discriminates between one State and another.
Parliament can make this type of law but only in case of famine or scarcity of goods in part of
India.12
Tax can also be imposed on the goods imported from other State by State, if similar goods are
manufactured in that State also. State may impose reasonable restriction on the freedom of
trade, commerce and intercourse in public interest but this power is also restricted because
State legislature cannot make a law regarding trade and commerce that discriminates between
the States and the other restriction over the power of State legislature is that they cannot
introduce the bill of imposing restriction over trade and commerce in State legislature without
the previous sanction of President.13
Other provision is that if there would be any restrictions over trade and commerce under the
existing laws then they would be in force unless the president directs otherwise, Article 301 is
also subjected to the Article 19(6)(ii) of Indian Constitution.14
After studying these provisions, an expression is created in mind that these all provisions are
exception to Article 301 but that cannot be true. Article 304 is an addition to Article 301 and
it prohibits the discrimination in inter-State trade, commerce and intercourse. Similarly
Article 304(a) prohibits the discriminatory taxes without the need to prove the violation of
10
D. D. Basu, SHORTER CONSTITUTION OF INDIA, 885 (12th edn., 2000).
11
12
Article 303(1) & (2), THE CONSTITUTION OF INDIA, 1950.
13
Article 304(a) & (b),THE C ONSTITUTION OF INDIA, 1950.
14
Article 305, (Saving of existing laws and laws providing for State monopolies- Nothing in Article 301 and
303 shall affect the provisions of any existing law except in so far the President may by the order otherwise
direct; and nothing in Article 301shall affect the operation of any law made before the commencement of the
Constitution (Fourth Amendment) Act, 1955, in so far as it relates to, or prevent Parliament or the legislature of
the State from making any law relating to, any such matter as is referred to in sub-clause (ii) of clause (6) of
Article 19) THE CONSTITUTION OF INDIA, 1950.

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freedom under Article 301. Article 30715 enables Parliament to establish an authority for
carrying out the provisions of Articles 301-304. All these provisions in no way restrain the
freedom ensured in Article 301.16
Court’s view on Compensatory Tax:
Article 301 says that trade, commerce and intercourse throughout the territory of India shall
be free. This Article should be understood in such a manner that it facilitates trade and
commerce throughout the territory of India and it must allow some degree of regulatory
control irrespective of the restrictions imposed by Part XIII of Indian Constitution. And
Hence, Regulatory measures and compensatory tax should not be considered as violative of
Article 301. The Indian Courts have applied the concept of regulatory and compensatory
taxation to the State taxation under entries 56 and 57 of list II. The reason behind it is that
compensatory and regulatory measures facilitate, rather than hamper, the flow of trade and
commerce.17
It is pertinent to bear in mind that all taxation is not necessarily an impediment or a restraint
in the matter or trade, commerce and intercourse. Instead of being such impediments or
restraints, they may, on the other hand, also provide for improvement of different kinds of
means of transport, for example, in tea leaves growing areas, unless there are good roads,
facility for transport of tea leaves from farms to whole country may be difficult, costly and
insufficient. In order to make new roads as also to improve old ones, cess on the grower of
tea leaves or others interested in the transport of this commodity has to be imposed. It is the
tax thus realized that makes it feasible for opening new means of communication or for
improving old ones. It cannot therefore, be said that taxation in every case must mean an
impediment or restraint against free flow of trade and commerce.18
The researcher has observed that the concept of compensatory and regulatory tax is complex
and so many times it has affected the freedom of trade and commerce throughout the territory
of India. In this chapter researcher has tried to discuss the views of Supreme Court on
15
16
M. P. Jain, INDIAN CONSTITUTIONAL LAW, (5th edn., 2008).
17
Juhi Bansal, Entry Tax: Is it Constitutional?, available at http://www.servicetaxindia.co.in/forms/entrytax.pdf
(Last visited on April 8, 2012).
18
Report of The Commission on Centre-State Relations, Evolution of the Centre-State Relations in India, Vol.
1, (March 2010) available at http://interstatecouncil.nic.in/volume1.pdf (Last visited on April 8, 2012).

128
different cases regarding compensatory tax. The first case regarding this issue was Atiabari
Tea Co. Ltd. v. State of Assam19 and then at regular intervals SC gave its decisions in
different cases but the main problem was that SC could not able to give the reasonable
method to levy compensatory tax. 20
In 2006, SC gave the verdict in Jindal Stainless Ltd. (2) v. State of Haryana21, where the most
reasonable method of proportionality was found out and hence the complexity of determining
the compensatory tax came to an end.
So, the researcher will discuss and analyze the decisions which have been given SC till
Jindal22 case.
In Atiabari Tea Co. Ltd. v. State of Assam23, A tax was levied under Assam Taxation Act,
1954 by the State of Assam on the carriage of tea by road or inland waterways which was
held invalid because the reason behind the levy of tax was to increase the revenue of State
and thus "directly affects the freedom of trade as contemplated by Article 301." The Supreme
Court took the view that the freedom guaranteed by Article 301 would become erroneous if
the movement, transport, or the carrying of goods were allowed to be impeded, obstructed or
hampered by the taxation without satisfying the requirements of Article 302-304.
In the course of judgement, Gajendragadkar, J. said that restrictions, freedom from which is
guaranteed by Article 301, would be such restrictions as directly and immediately restrict or
impede the free flow or movement of trade throughout the territory of India. On the other
hand, indirect or remote restrictions on the free flow or movement of trade would be
permissible under Article 301.
The Court did not take into consideration the quantum of burden of tax, which by no means
was excessive. Simply because the tax was levied on 'movement' of goods, from one place to
another, it was held as violative of Article 301. And hence the taxation law was also declared
as void. The view set out in Atiabari was bound to have great adverse effect upon the
financial autonomy of the States. It would have rendered their taxing power under entries 56
and 57, List II.
19
Atiabari Tea Co. Ltd. v. State of Assam, AIR 1961 SC 232 (Supreme Court of India).
20
Report and Recommendations of Sarkaria Commission, Trade, Commerce and Intercourse Within the
Territory of India, (January 1988) available at http://interstatecouncil.nic.in/CHAPTERXVIII.pdf (Last visited
on April 8, 2012).
21
Jindal Stainless Ltd. (2) v. State of Haryana, AIR 2006 SC 2550 (Supreme Court of India).
22
Jindal Stainless Ltd., AIR 2006 SC 2550 (Supreme Court of India).
23
Atiabari Tea Co. Ltd. v. State of Assam, AIR 1961 SC 232 (Supreme Court of India).

129
As the Assam Taxation Act, 1954 was not fulfilling the conditions under Article 304(b), it
was amended in Kheyrbari Tea Co. v. State of Assam24, where the same issue of levying tax
to enhance State revenue was arisen. The contention of State was that it was compensatory
tax but as the tax was directly impeding the free flow of trade, it was held violative of Article
301.
The matter of Atiabari25 case was reconsidered in Automobile Transport Ltd. v. State of
Rajasthan26 by SC. In this case, the State of Rajasthan had levied a tax on motor vehicles (
Rs. 60 on a motor car and Rs. 2000 on a goods vehicle per year) used within the State in any
public place or kept for use in the State. And hence, the validity of the tax was challenged.
The freedom of trade and commerce under Article 301 should not unduly interfere with the
State autonomy, and it should be consistent with an orderly society, the Supreme Court now
ruled that regulatory measures and compensatory taxes for the use of trading facilities were
not hit by Article 301 as these did not hamper, but rather facilitated, trade, commerce and
intercourse throughput the territory of India.
The main issue in this case was to deduce a working test to decide whether a tax is
compensatory or not because it was to enquire whether the trading people are having the use
of certain facilities for the better conduct of their business and paying not patently much more
than what is required for providing the facilities. A tax does not cease to be compensatory
because the precise or specific amount collected is not actually used in providing facilities.
The Court had to define what a compensatory tax or regulatory measure was. A regulatory
measure, the Court said, is a measure which actually facilitated trade, though it appeared to
harm it. For instance, the rule that a merchant’s car loaded with wares must stop at a red
traffic signal is a purported restriction on the movement of trade, but actually facilitates it,
since it ensures that cars do not destroy each other, and in the process, trade.27
The concept of compensatory tax evolved in this case was something new as compared to
Atiabari28 case, the Court had dismissed the argument that the money collected through the
tax would be used to improve roads and waterways rather curtly by saying that there were
other ways, apart from the tax in question, to use the money, and that if the said object was
24
Kheyrbari Tea Co. v. State of Assam, AIR 1964 SC 925 (Supreme Court of India).
25
Atiabari Tea Co., AIR 1961 SC 232.
26
Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan, AIR 1962 SC 1406 (Supreme Court of India).
27
V. Niranjan, Interstate Trade and Commerce: The Doctrine of Proportionality Reaffirmed, THE INDIAN
JOURNAL OF CONSTITUTIONAL LAW, (2008), available at http://www.indlaw.com/display.aspx?58B0AEB6-
20B3-46BA-8CEF-21E8411C23EF (Last visited on April 8, 2012).
28

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intended to be achieved by levying a tax on the carriage of goods, the same could be done
only by satisfying Article 304(b).29
The Court ruled that Article301 did not hit the tax, as it was a compensatory tax having been
levied for use of the roads provided for and maintained by the State. Thus, to this extent, the
majority view in Atiabari30 case was now overruled by Automobile.
Since then the concept of regulatory and compensatory taxes has become established in India
with reference to entries 56 and 57, List II, and the concept has been applied in several cases,
and progressively the Courts have liberalized the concept so as to permit State taxation at a
higher level.31
In State of M.P. v. Bhailal Bhai32, a tax was imposed under Madhya Bharat Sales Tax Act,
1950 on sales of tobacco leaves, manufactured tobacco and tobacco used for bidi
manufacturing and it was payable at the point of sales by importer in Madhya Bharat. The
petitioners contended that the tax was unconstitutional as it was violative of Article 301.
Das Gupta, J., held that the tax was violative of Article 301 as it was directly impeding the
freedom of trade and commerce. This case was not considered as the exception under Article
304(a), because similar goods manufactured in taxing State were not subjected to the
impugned tax. And hence the final verdict went into the favour of petitioners.
In State of Assam v. Labanya Probha33, tax was levied on motor vehicles with the rate of Rs.
56 per seat in State. The petitioner challenged the tax as violative of Article 301 due to
impediment in free flow of trade and commerce. Court rejected the plea by following the
judgement in Automobile Transport34 case, and held that the tax law was only regulatory
measure imposing compensatory taxes for facilitating trade, commerce and intercourse.
Later in Andhra Sugars Ltd. v. State of A.P.35, the validity of section 21 of The Andhra
Pradesh Sugarcane (Regulation of Supply and Purchase) Act, 1961, which imposed the tax on
purchases of all sugarcane required for use, consumption or sale in a factory and hence
petitioner challenged the tax as that it was violating Article 301.
There was no discrimination between the sugarcane produced in the State and imported from
outside. The Court upheld the section and pointed out that generally a tax on the good does
29
D. D. Basu, Commentary on The Constitution of India, Vol. 5, 78 (6th edn., 1986 ).
30
31
Akanksha Bhadouria, Are regulatory and compensatory taxes violative of article 301?, available at
http://www.legalserviceindia.com/articles/taxes_int.htm (Last visited on April 8, 2012).
32
State of M.P. v. Bhailal Bhai, AIR 1964 SC 1006 (Supreme Court of India).
33
State of Assam v. Labanya Probha, AIR 1967 SC 1575 (Supreme Court of India).
34
Automobile Transport, AIR 1962 SC 1406.
35
Andhra Sugars Ltd. v. State of A.P., AIR 1968 SC 599 (Supreme Court of India).

131
not restrict the free flow and movement or transport of goods and hence it does not violate
Article 301.
After that in State of Madras v. Nataraja Mudaliar36, petitioner challenged the assessment
under the Central Sales Tax Act, 1956. Shah, J., observed that the tax under Central Act on
inter-State sales is in its essence a tax hampering movement of trade and commerce since by
definition in the act, a sale or purchase of goods is deemed to take place in the course of inter-
State trade and commerce if the goods are transported from one State to another or if there
would be transfer of title deeds or documents to the goods from one State to another, and as a
result it was held that the tax fell within the prohibition of Article 301.
However it was saved under Article 302 which empowers parliament to make a law in public
interest. In the final verdict Bachawat, J., upheld the tax by following the reasoning in
Andhra Sugars Ltd. v. State of A.P.,that generally a tax on sales of goods did not directly
impede or restrict the free flow or transport of goods.
In Nazeria Motor Service v. State of A.P.37, in this case also there was a taxation act in
Andhra Pradesh which was levying tax on vehicles within the State in any public place or
kept for use in the State. As a result it was argued that the purpose of tax was only to raise the
State revenue and not facilitating the trade and commerce in State. It was not considered as
compensatory or regulatory. Even though there had been compliance with the proviso to
Article 304(b) in the matter of obtaining the sanction to levy the tax but it was always open to
Court to reconsider the reasonableness of tax and also have power to inquire whether the
imposition was in public order. Hence in the final verdict Court held it as invalid and
declared the tax as void due to the violation of Article 301.
Later in G.K. Krishnan v. State of Tamil Nadu38, The State of Tamil Nadu increased the
motor vehicles tax from Rs. 30 to 100 per seat per quarter and this was challenged as being
violative of Article 301
The main issue was that whether a non-discriminatory tax levied by a State should be
considered as a restriction on trade and commerce because of the feeling that this would
restrict the State autonomy to levy taxes falling in the State legislative sphere?
But the Supreme Court upheld the tax. The Court Stated, "A compensatory tax is not a
restriction upon the movement part of trade and commerce. The tax should not go beyond a
36
State of Madras v. Nataraja Mudaliar, AIR 1969 SC 147 (Supreme Court of India).
37
Nazeria Motor Service v. State of A.P., AIR 1970 SC 1275 (Supreme Court of India).
38
G.K. Krishnan v. State of Tamil Nadu, 1975 AIR SC 583 (Supreme Court of India).

132
proper recompense to the State for the actual use made of the physical facilities provided in
the shape of a road."39
In the instant case, the tax collections amounted to over Rs. 16 crores while the expenditure
for the year amounted to Rs. 19.51 crores and this amount did not include the grants to local
governments for the repair and maintenance of roads within their jurisdiction. The tax was
thus held to be compensatory and hence valid. The Supreme Court further liberalized the
State taxing power by upholding a State tax on passengers and goods carried on national
highways.
Further in Bolani Iron Ores v. State of Orissa40, A compensatory tax is levied to raise revenue
to meet the expenditure for building roads, maintaining them and for facilitating the
movement and regulation of traffic. The Supreme Court held that taxation under entry 57,
List II, couldn’t surpass the compensatory nature, which must have some link with the
vehicles using the roads. The regulatory and compensatory nature of the tax is that taxing
power should be used to levy taxes on motor vehicles, which use the roads in the State or are
kept for use thereon.
Later in, International Tourist Corporation v. State of Haryana41, The State of Haryana
levied a tax on transporters plying motor vehicles between Delhi and Jammu & Kashmir.
They use national highway, pass through Haryana without picking up or setting down any
passenger in the State. The responsibility for constructing and maintaining of national
highways rests on the Centre. It was therefore argued by the transporters that the tax could
hardly be regarded as compensatory, but the Court rejected the contention.
The Supreme Court said that what is necessary to uphold such a tax is the existence of a
specific, 'identifiable' purpose behind the levy and a 'sufficient link between the 'subject and
the object of the levy.' The Court further said that a State spends so much over maintenance
of roads and providing facilities for transport of goods and passengers. Even in connection
with national highways, a State spends considerable amount not directly by constructing or
maintaining them but by facilitating the transport of goods and passengers along with them in
a range of ways such as lighting, traffic control, amenities for passengers, halting places for
buses and trucks. That part of a national highway which lies within the limits of municipal is
to be developed and maintained by the State.
39
G.K. Krishnan, 1975 AIR SC 583.
40
Bolani Iron Ores v. State of Orissa, 1975 AIR SC 17 (Supreme Court of India).
41
International Tourist Corporation v. State of Haryana, 1981 AIR SC 774 (Supreme Court of India).

133
There is thus sufficient link between the tax and the passengers and goods carried on the
national highways to justify the imposition of the said tax. Hence, in the final verdict SC held
the tax valid.
In State of Karnataka v. Hansa Corpn.42, one of the important principles was established that
Article 304(a) imposes a limit on the power of the legislature of a State to impose tax which
may be discriminatory in character. There is a primary assumption in Article 304(a) that such
a tax when levied within the limits of Article 304(a) would not be violative of Article 301 and
State legislature has the power to levy such a tax.
In Malwa Bus Service v. State of Punjab43, in the year 1981, the State of Punjab substantially
increased the rate of tax on every stage carriage plying for hire and transport of passengers.
The rates adopted were Rs. 500 per seat per year subject to a maximum of Rs. 35,000 per bus
irrespective of the distance over which it operated daily. According to the budget statistics for
1981-82, the revenue receipts of the government from motor vehicles tax was Rs. 50 crores
as against the expenditure of Rs. 34 crores. The tax was challenged on the ground that it was
not compensatory as the government was using it for increasing its general revenues, but the
Court upheld the tax as compensatory.
In this case, the budget expenditure on the roads and bridges did not include the expenditure
spent by the State on other heads connected with road transport, such as, the directorate of
transport, transport authorities, provisions for bus stands, lighting, traffic police, and grants to
local authorities. Taking all this expenses into consideration, it became clear that a significant
part of the levy on motor vehicles was being spent annually on providing facilities to motor
vehicles operators.
The Court also commented that in later years, the government expenditure on roads and
bridges had considerably increased. It also said that the figures of income and expenditure for
only one year might present a distorted picture. In this case, growing figures of receipts and
expenditure for nine years (1973-1982) presented a different picture. Describing the principle
underlying such a tax, the Court said: "what is essential is that the burden should not
disproportionately exceed the cost of the facilities provided by the State." And hence the tax
imposed by the State of Punjab was held to be valid by SC.
Further in case of Meenakshi Alias Rama Bai v. State of Karnataka44 , the Court supported
the increase in the passenger tax on the vehicles of Bus Operators in spite of the fact that the
42
State of Karnataka v. Hansa Corpn., AIR 1981 SC 774 (Supreme Court of India).
43
Malwa Bus Service v. State of Punjab, 1983 SCC (3) 237 (Supreme Court of India).
44
Meenakshi Alias Rama Bai v. State of Karnataka, AIR 1983 SC 1283 (Supreme Court of India).

134
imposition was made to reimburse the loss of revenue due to abolition of octroi. In the course
of keeping the tax laws outside from the purview of Article 301, the Court has even relaxed
the limitation under Article 304(a). Upholding the validity of State Notifications giving tax
exemptions to or imposing lower rate of tax on certain goods made within the State, the Court
held that the notifications do not violate Article 301 and therefore do not violate Article
304(a) also.
Then in Maharaja Tourist Service v. State of Gujarat45, a tax was imposed on all omnibuses
which were exclusively used or kept for use in the State as contract carriages. In this case the
tax was held as compensatory in nature by SC. SC explained that to uphold a tax on the basis
of its being compensatory, existence of link between the subject and object of the levy is
necessary. But, it is not necessary to show that the whole or a considerable part of the tax
collected is used. The State is free to decide the rate of tax keeping in view the guideline that
the tax is compensatory or regulatory.
After this case, SC progressively liberalised the concept of a compensatory and regulatory tax
in course of time. In Bhagatram Rajeev Kumar v. Commissioner of Sales Tax46, the Court has
observed “The concept of compensatory nature of tax has been widened and if there is
substantial or even some link between the tax and the facilities extended to such dealers,
directly, or indirectly the levy cannot be impugned as invalid.”47
Later the SC has further liberalised the concept in verdict in State of Bihar v. Bihar Chamber
of Commerce48. The Bihar Legislature imposed a tax on entry of goods into local area for
consumption, use or sale therein at a rate, not exceeding 5%, as may be specified by the State
government. The tax fell under Entry 52, list II. The question before the SC was that whether
he tax was violating Article 301. As the tax was imposed on the entry of goods into a local
area, it was a tax on the movements of the goods so the question was arisen whether the tax
was compensatory in nature.
The SC held the tax valid as being compensatory in nature. The important point to note is that
nowhere such a link between the imposition of tax and provisions of such facilities was
mentioned. The State produced no material to ascertain that the levy was of the compensatory
and regulatory in nature. But the Court held this situation as being of “no consequence” for
the reason that the Court can take “notice” of the fact that the State does make available
several facilities to the trade including maintenance of roads, water-ways and markets, etc.
45
Maharaja Tourist Service v. State of Gujarat, AIR 1991 SC 1650 (Supreme Court of India).
46
Bhagatram Rajeev Kumar v. Commissioner of Sales Tax, (1995) 96 STC 645 (Supreme Court of India).
47
Bhagatram Rajeev Kumar, (1995) 96 STC 645.
48
State of Bihar v. Bihar Chamber of Commerce, AIR 1996 SC 2344 (Supreme Court of India).

135
In Geo Miller v. Madhya Pradesh49 , which had faced the same situation that the respondent
contended that the tax being imposed is compensatory in nature because the revenue
collected from there passes over to local bodies to compensate them for the loss incurred due
to abolition of octroi. Their main argument was that by enhancing the finance they would
enable to promote Municipal Services more efficiently which will help in the free flow of
trade and commerce. Hence the tax was held valid.
Jindal50 case has its origins in a commercial dispute that the Supreme Court considered in
2003. The Haryana Local Area Development Tax Act, 2000, sought to tax the transport of
raw materials required by the Haryana industries which sent finished products to other States.
The petitioners challenged the Constitutionality of this Tax Act, their contention was that it
violated Article 301. A Division Bench of the Supreme Court referred it to a larger Bench, to
consider whether the decisions in Bhagatram51 and Bihar Chamber 52were correct.
These issues were considered in detail by the Constitution Bench in 2006. The petitioners
argued that if Court accepts the Bhagatram test then it would eliminate the distinction
between a compensatory tax and a tax for general revenue. The respondents made two
important arguments which were eventually rejected. Their first argument was that a
compensatory tax does not have to be in proportion to benefit, because that would make it
impossible to differentiate from a fee, and their second argument was that in any event, the
factor on which a tax is considered as compensatory cannot be the nature of the levy, but the
nature of the legislative entry under which the relevant law is passed. It was argued that
Entries 56, 57 and 59 of List II indicate a link with roadways and waterways, and are hence
compensatory. It is significant that both sides relied on the comparison with a fee, and other
types of taxes.
Finally, in Jindal53 case the decision was that a tax whose amount is approximately equal to
the benefit granted on trade as a result of the levied tax will not attract Article 301, as the
nature of the tax is compensatory and regulatory. In other words, if the tax is used to improve
trade facilities through building infrastructure, and the level of this benefit to trade is not
disproportionate to the levy itself, the tax will be outside the pale of Article 301. Hence,
Jindal overruled the decisions of the Supreme Court in Bhagatram Rajeev Kumar54 and Bihar
49
Geo Miller v. Madhya Pradesh, A.I.R. 2004 SC 3552 (Supreme Court of India).
50
Jindal Stainless Ltd., AIR 2006 SC 2550.
51
52
Bihar Chamber of Commerce, AIR 1996 SC 2344.
53
54

136
Chamber of Commerce55, where the decisions was that if there would be any link between the
tax and the facilities extended to such dealers, directly, or indirectly the tax can’t be declared
as invalid.
After the decision in Jindal56 case, it was followed in Dinesh Pouches Limited v State of
Rajasthan and Others57, where petitioner filed the petition against Rajasthan Tax on Entry of
Goods into Local Areas Act, 1999 and his contention was that it was violating Article 301
because State had added “zarda mixed pan masala including gutkha and churi” in the list of
commodities on which tax was levied. It was held that tax on entry of goods into local area
having the effect of directly impeding the free movement of trade and commerce within the
State is not compensatory in nature and falls within the ambit of Article 301. Also it was
found that it was not fulfilling the requirements under Article 304(b). Hence Rajasthan Tax
on Entry of Goods into Local Areas Act, 1999 was held ultra vires of Article 301. The same
evolve in the case of Indian Oil Corporation Limited v. State of Uttar Pradesh and Ors58,
where the same matter was involved that on what basis the compensatory tax should be
calculated and the Court gave the decision on the basis of proportionality of tax with facilities
provided by following the Jindal59 case. As in this case State had not enough documents to
show the use of tax in providing facilities for trade and commerce and hence their petition of
compensatory tax has been rejected by the Court.
Later in Indian Oil Corporation Limited (Guwahati Refinery) v State of Assam and Others60,
Court, the Court followed the decision of Indian Oil Corporation61 case and held the
imposition of tax as valid under Article 301, because it was facilitating the trade instead of
hampering and hence the Court held the Assam Entry Tax Act, 2008 as valid tax law.
In recent case of 2011 i.e. NTPC Limited and another v State of Uttar Pradesh and others62,
where the State government had levied the tax on transportation of forest products mainly
Timber and it was high rated tax. State had justified it by saying that it is for better facilities
for the traders because the imposition will increase the cost of generation of power, and the
manufacture of essential goods necessary for creating infrastructure affecting the
development of the State. But they could not able to give a valid reason for high tax and
55
Bihar Chamber of Commerce, AIR 1996 SC 2344.
56
57
Dinesh Pouches Limited v State of Rajasthan and Others, 2007 Indlaw RAJ 80.
58
Indian Oil Corporation Limited v. State Of Uttar Pradesh And Ors., 2007 (10) VST 140.
59
60
Indian Oil Corporation Limited (Guwahati Refinery) v State of Assam and Others, 2009 Indlaw GUW 3.
61
Indian Oil Corporation Limited, 2007 (10) VST 140.
62
NTPC Limited and another v State of Uttar Pradesh and others, 2011 Indlaw ALL 1040.

137
Court held the tax as violative of Article 14, 19(1)(g), 301 because the tax was not
proportional to the facilities provided by the state.
Conclusion:
The position as it stands today is not as vague as it was during the time of the Atiabari and
the Automobile cases. We must settle the ratio in these two landmark cases. From the
discussion of the Supreme Court in the said cases, few important principles were established
first, that restrictions operate on freedom of trade and commerce remotely and indirectly do
not violate Article 301 and need not be justified under the provisions of Article 304 (b).
Second, that measures which operate directly and immediately on the freedom of trade,
commerce and intercourse may be violative of Article 301, unless it is not violative of the
reasonableness aspect guaranteed by Article 304 (b).
Last important principal was that those measures having direct and immediate effect will
come under the restrictive provisions of Article 301 provided that these measures are
compensatory or are regulatory.
To reconcile the freedom of trade and commerce and the power of taxation, the Supreme
Court has developed the concept of regulatory and compensatory tax. This means that Article
301 cannot stand in a way of a regulatory or compensatory tax. The concept of regulatory and
compensatory tax has been applied by Indian Courts mainly to the State taxation under
Entries 56 and 57 of List II. The need for imposing this type of a tax is to impose a levy on
trade and commerce at least to the extent of making it pay for the facilities provided by the
State, for example, a road network and other infrastructural facilities which are necessary for
free flow of trade and commerce. The reason for this is that taxes of this nature facilitate
rather than hamper the flow of trade and commerce.
It can be thus stated that the freedom of trade and commerce can be infringed in any manner
except for the situations when regulatory and compensatory measures are imposed. Thus,
there is a violation of this freedom only when a legislative or executive act operates to
hamper trade, commerce and intercourse, directly and immediately, different from creating
some indirect or inconsequential impediment that may be regarded as remote.
Only taxes that directly and immediately restrict trade will be in contravention to Article 301.
When a tax is imposed solely on the basis that goods are carried or are transported, it would
affect the freedom of trade and commerce, or when a tax that discriminates between goods of

138
one State and another is imposed, it would violate Article 301. Further it has to be concluded
that only those taxes that directly hamper the trade or business will be void, otherwise no tax
can be cancelled by declaring it as being violative of Article 301. Laws, which are purely
regulatory and compensatory in nature, are not violative of the freedom so guaranteed.
Researcher will conclude with last that we need a strong and powerful constitutional
authority to run the trade and commerce freely throughout the territory of India under Article
307.

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South -Asian Journal of Multidisciplinary Studies: ISSN:2349-7858 Volume 2 Issue 4 (SJIF:2.

THE CONCEPT OF COMPENSATORY TAX & ITS RELEVANCE TO

Raghuveer Singh Meena1

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Scope of Article 3016 of Indian Constitution:

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Court’s view on Compensatory Tax:

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

Published By :Universal Multidisciplinary Research Institute Pvt Ltd

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