*Rahul Agrawal and Muskaan Goyal

(Source: Gemini)

The Supreme Court in recent ruling upheld the aspect theory allowing both Centre and State to impose tax on various aspects of the same activity. The constitutional justification of dual taxation is a validation of cooperative federalism yet it creates questions and demands for various policy and legislative reforms.

Opening Thoughts

Consider you are watching your favourite show on some streaming platform and you had paid subscription fee but now the state is charging you a tax on entertainment just for enjoying the show. Sounds unfair? However, according to the Supreme Court, it is constitutionally right. This constitutional conflict was encountered in the State of Kerala v. Asianet Satellite Communications Ltd. (‘Asianet’). The apex court upheld the doctrine of aspect theory by holding that various aspects of a single activity may be taxed by both the Centre and the state without encroaching into the sphere of legislative activity of the other.

The current judgment takes on a special significance as digital consumption continues to increase, the legal need to define the scope of the term “entertainment”, and regulate the issue of who, precisely, should bear the taxation burden, increases as well. With the spread of digital services, the debate of concurrent taxation has been heating up as States demand the right to impose tax on entertainment consumption while the Centre wants to maintain its control on service transmission. 

In this blog, we will see the rationale based on which the Supreme Court has passed this verdict and also look at the future implication of this verdict on Indian taxation and fiscal policy.

Understanding the aspect theory in terms of law

The central argument is the Aspect Theory, which is a principle that gives provisions of dual taxation when different constitutional aspects of the same transaction are being handled. Simply stated this doctrine permits distinct legislative authorities, Central and State, to levy taxes or to regulate the same subject matter so long as each legislature acts under a different aspect of law. This theory is based on the assumption that one transaction may be multi-dimensional, i.e., each dimension of the transaction may represent a different constitutional entry as mentioned under the Seventh Schedule of the Indian Constitution.

The aspect theory exists in parallel with the pith-and-substance doctrine, which questions the real nature of legislation in order to establish an answer to the resolution of possible conflicts. More importantly, however, aspect theory is much broader: it does not resolve conflicts, but permits parallel existence. The Supreme Court has previously applied this doctrine in cases like, Federation of Hotel & Restaurant Association of India v. Union of India and T.N. Kalyana Mandapam Association v. Union of India, etc., but in the Asianet Case, it decisively used it to agree to the dual taxation of digital entertainment and redefined Digital Entertainment.

Redefining of Digital Entertainment under the Prism of Dual Taxation

Asianet Satellite Communications Ltd. was in a position of paying not a single but two taxes on the same activity. The imposition of service tax by the Centre and Entertainment tax by the State created a basic question, was it constitutionally valid that both the Parliament and State Legislatures could impose separate taxes on the same broadcasting activity?

The essence of the argument was that the petitioners were already paying service tax for the transmission of TV signal, and it would be unfair for that same activity to be taxed again by the state in the face of entertainment. To this, the States claimed that the viewers are not receiving mere service but entertainment as well – a subject explicitly mentioned under Entry 62 of List II. This problem became important when more than 40 writ petitions and appeals were filed by big DTH and cable operators. Leading to State of Kerala v. Asianet Satellite Communications Ltd becoming a landmark judgment settling the constitutional debate on dual taxation of broadcasting service. As digital and direct-to-home entertainment grew, this issue quickly turned into a bigger constitutional problem, affecting federal tax powers, online business models, and what consumers have to pay.

In order to resolve this argument, Supreme Court resorted to two existing principles- aspect theory and doctrine of pith and substance. It ruled that even though the activity is singular, its different aspects can be taxed. The act of providing service falls within the ambit of the Centre’s power under entry 97- list I, and the other aspect of viewing content by assessee falls within the ambit of the state’s power under entry 62- list II. Through the doctrines, the court opined that these taxes are not duplicative but they are instead different facets of the same activity.

As per aspect theory, the court observed that a single activity is capable of having different aspects, which could fall under the jurisdiction of different legislatures. In the case of broadcasting, it is a service that provides entertainment to consumers. Hence, both the aspects of “service” and “entertainment” are squarely within the taxing capacity of the Centre and State, respectively. 

While reinforcing the doctrine of pith and substance the court stated that a law must be judged by its dominant purpose rather than the incidental overlap. It explained that a law may indirectly affect a topic in the other List but it is still good provided that its substantial aim falls within the area of authority of the government doing the legislating. So, in this case, the state and centre both are acting within their explicit jurisdiction, and hence both taxes can coexist. Moreover, the conventional perception of entertainment was expanded as it was entering the private areas, the legislation and the taxes could not keep up. Traditionally, “entertainment” referred to movies in theatres or public shows only, but in line with today’s era, where people prefer Netflix over theatres, it includes everything from cable television to DTH and OTT platforms like Netflix or Amazon Prime. The Court remarked, entertainment today can be provided within private spaces and even in vehicles through television or other electronic gadgets.

By harmonising the co-existence of service and entertainment tax, the SC declared both taxes valid as they were distinct and did not amount to duplication. Through it, it maintained the constitutional balance of Centre and State powers and adjusted the meaning of the law to the changing environment of digital entertainment.

Future Perspective: Policy Implications and Legal Reflections after Asianet

Although the decision of the Supreme Court in the Asianet case, undoubtedly empowers the doctrine of federal coexistence and the concept of the aspect theory, by reaffirming the constitutionality of the dual taxation, its practical consequences on the fast-developing digital economy of India are a matter of serious policy reflection and lawmaking. Although, legally sound, the judgement poses a ‘policy puzzle’ which requires reconsideration of stance on digital taxation to avoid economic regression and fiscal fragmentation.

Increasing cost for consumers: Demanding a call for Policy Review

The judgement poses its direct and immediate effect on the consumer. Take a streaming start-up, which already pays 18 percent of GST, on top of which Karnataka imposes a 5 percent entertainment cess, and then probably, a municipal tax. For a common viewer, the entertainment and service are one single transaction. The cumulative tax burden severely hurts the pocket of a monthly binge watcher and it is economically retrogressive.

Although it is true that a lot of products, including alcohol and petrol, are taxed to such a high level with different compliance requirements in different states, the taxation of digital entertainment has its own peculiarities that require a separate policy solution. The content that was previously confined to the cinemas and live shows is now available as the cheap digital content that is consumed by students, middle-class families, and rural consumers as a means of education and entertainment. Placing a “two-fold financial burden” on these sectors, particularly the “less resourceful” is a matter of economic fairness. Even the court itself acknowledges that not everything that is interpreted in the Constitution is always in line with everyday economic perception. Consequently, although it is legally correct, the practical implication of the rise in consumer expenses is a strong reason why the legislative and executive arms of government should consider and possibly rationalize the total tax burden on digital entertainment.

Fiscal Fragmentation and a threat to Unified Digital Market

Beyond the consumer, the verdict also raises serious implication on the idea of a unified digital market in India. When the states are allowed to impose parallel taxes on the services within the GST regime, it would compel platforms to customize prices and compliance to the 28 states. Nevertheless, it is usually not in the best interest of the states to implement this in preference to revenue, because the market distortions that may be introduced, the loss of business activity, the possibility that investors will lose confidence, and the threat that extending their ability to tax widely at the cost of market simplicity may be worse than short-term gains to the states in increasing the volume of their revenues. A common GST will provide scale efficiencies, reduced compliance costs, the development of the digital economy and improved long-term revenue collection by providing incentive on economic activity, which is better in the long-term sustainable interests of the states. The danger that this ruling will unwittingly extend tax powers at the expense of an integrated digital marketplace further supports the significance of prioritising harmonized tax regime over the dual taxation regime. This disjointed taxation is a direct negation of the very spirit of GST, which is, one nation, one tax.

The decision leaves a loophole in which states are free to levy taxes on digital entertainment and services in the name of entertainment tax or luxury tax. This causes the problem of jurisdictional demarcation, predictability of fiscal and viability of an integrated tax regime. Compliance requirements on the part of the service providers will also get more complicated, which may discourage investment and innovation in the Indian digital sector. The risk that the decision will unintentionally expand broad taxation power at the expense of simplicity in the markets is high.

Policy Reforms and Legislative Recommendations

Since the legislative sphere is well within the fiscal policy and equal taxation, the debate should be switched between evaluating the legal basis of the judgment to developing sound policy and legislative remedies.

1. Intervention of GST Council: GST Council being the highest organ of indirect taxation is well poised to solve this problem. It must look at the possibility of putting digital entertainment services in a clearer and more integrated GST base. It may entail the specification of the term entertainment in the context of GST, so that states cannot levy their own levies, which would split up the tax base.
2. Revenue Sharing Mechanism: In order to satisfy the states on the revenue concerns and yet have a single unified tax structure, the government may look into revenue-sharing mechanisms between the Centre and States on taxes payable on digital services. This would make states get their fair share without making a quilt of taxes.
3. Harmonization by Model Laws or Inter-State Agreements: In case states are left free to the taxes on entertainment, there should be some attempt to harmonise such taxes. This may include working out model laws that may be adopted by states or reaching inter-state agreements to create some level of uniformity in tax rates and compliance processes of digital services.
4. Legislative Clarity and Redefinition: The legislative clarity is necessarily urgent in defining the term entertainment as it applies to digital services. Laws, which were formulated in a different period, have failed to keep up with the growth of entertainment in the personal digital areas. The taxing powers should be well defined in new legislation to eliminate confusion and multiple, overlapping taxes.
5. Cumulative Tax Burden: An overall review of cumulative tax burden on digital entertainment should be done by the policymakers. Although constitutional power of taxation has been established, the tax system should be economically viable and fair to both consumers and service providers so that the tax system does not hinder but promote the development of digital economy in India.
   

Concluding Thoughts

The constitutional validity of dual taxation and federal co-existence as upheld by the Supreme Court in the Asianet case poses huge policy problems to the digital economy of India. The economic repercussion, especially the so called two-fold financial burden on the consumers and the danger of disintegrating the so called unified digital market, cannot be overlooked. Although the legal stand has been made clear by the judiciary, the legislature and the GST council now have the responsibility of coming up with transparent and co-ordinated policies. Simple definitions, alignment of taxation systems, re-evaluation of accumulative tax burden are some of the measures that should be taken to make sure that the development of digital services in India is not suppressed by a complicated and economically retrogressive taxation system.

*Rahul Agrawal and Muskaan Goyal are 3rd year students studying at Hidayatullah National Law University, Raipur.