Knowledge

“Co-operative Federalism” has been an oft-repeated mantra of the present Central Government. In that backdrop, it has been surprising to note the service tax proposals under the Union Budget 2015 stirring the hornet’s nest of conflict between taxation powers of the Union and States under the Constitution on more than one count. In this article, we would discuss one such instance, viz., the proposal to levy service tax on lottery ticket distributors – an issue with a long history of litigation.

As a background to the issue, it is pertinent to understand that a “Principal lottery ticket distributor” procures lottery tickets in bulk from the Government and resells those to the public through various agents, stockists, resellers, etc. The margin made by such a distributor at the first sale is sought to be made subject to service tax. Historically, the argument of the service tax authorities in this regard has been that the principal distributor is rendering services such as promotion, marketing and sale of lottery tickets of the state and this margin is in the nature of commission paid to such a service provider.

Time and again, the Government has tried to bring the sale of lottery tickets by the distributors under the ambit of service tax. However, on one or the other count, this levy has consistently been struck down by the judiciary. The following passages bring out the history of this litigation, the issues therein and how the government has yet again sought to levy service tax on this transaction.

Prior to 16.05.2008

The government introduced the levy of service tax on the distributor of lottery tickets under the head of ‘Business Auxiliary Service’ by reading the sale of lottery tickets as ‘sale of goods’. ‘Business Auxiliary Service’ was defined to include (i) promotion or marketing or sale of goods produced or provided by or belonging to the client. (ii) Promotion or marketing of services provided by the client.

This levy was challenged before the Sikkim High court in the case of Martin Lottery Agencies vs. Union of India - 2007 (8) STR 561 (Sikkim). The Sikkim High Court took note of the decision of the Constitution Bench of the Supreme Court in the case of Sunrise Associates v. Govt. of NCT of Delhi (2006) 5 SCC 603 (which held that lottery tickets are ‘actionable claims’ and not goods within the meaning of Sale of Goods Act) and held that as there is no promotion or marketing of ‘goods’, there can be no levy of service tax.

After 16.05.2008

Thereafter a Special Leave Petition was filed against the aforesaid judgment (of “Martin Lottery Agencies” supra). During the pendency of this petition, the Parliament by Finance Act, 2008 inserted an explanation in sub-clause (ii) of Section 65(19), which came into force on 16-5-2008. Promotion, marketing, and sale of lottery tickets was now declared to be a taxable service under the head of ‘Business Auxiliary Service’ by deeming it to be promotion of services provided by a client. Also, the said explanation was given effect retrospectively. The Supreme Court decided to deal only with the issue of retrospective operation of the said explanation and held that the same can only be made effective prospectively. The Supreme Court however, did not strike down the explanation.

From 1.07.2010 onwards

From 1.07.2010 onwards Section 65(105)(zzzzn) was introduced in the Finance Act 1994 under which the promotion and sale of lottery tickets was sought to be made an independent service altogether. The whole route of taxing the same through Business Auxiliary Service was discarded. The government thus alleged that the activity of the principal distributor fell under this service category and was thus eligible for service tax.

At this juncture, the constitutional validity of the said provision was successfully challenged before the Sikkim High Court in the case of Future Gaming Solutions Pvt Ltd. vs. Union of India [reported belatedly in 2015 (37) STR 65] on the ground that taxes on betting, gambling and lottery fall within the ambit of the State List under entries 34 and 62 and hence the Union cannot impose tax by resorting to the residuary entry 97 of the Union List (“Any other matter not enumerated in List II or List III including any tax not mentioned in either of those Lists.”) and thus encroach upon the power of state governments. Another argument which was taken and upheld was that sale of lottery tickets is merely a sale and there is no element of service being provided. The said argument was upheld and Section 65(105)(zzzzn) was held unconstitutional.

From 1.07.2012 onwards

In the year 2012, the entire Service tax regime was changed from a selective levy approach to a comprehensive approach. Section 65B(44) defined the term ‘services’ and it specifically excluded transactions in money and actionable claims from the definition of “service”. Also, betting, gambling and lottery falls under the Negative List under Section 66D. As per the judgment of Sunrise Associates (supra), lottery tickets were clearly actionable claims and not goods. Accordingly it could have been construed that the sale of lottery tickets is outside the scope of the term ‘service’ and hence not eligible for service tax. However, vide Notification 36/2012-ST, Rule 6 of the Service Tax Rules, 1994 was amended to make the principal distributor of lottery tickets liable to pay service tax in accordance with the rate specified therein.

The constitutional validity of the Notification was challenged as it was ultra-vires the parent service tax legislation which had specifically included lottery in the Negative List under section 66D. The Court ruled that notification, being a subordinate legislation, cannot impose tax. (Future Gaming Solutions India Pvt. Ltd. vs. Union of India- 2014 (36) STR 733 (Sikkim))

Proposals under Budget 2015

Clause (31A) has been inserted specifically in Section 65B defining “lottery distributor or selling agent” to mean a person appointed or authorized by a state for the purposes of promoting, marking, selling or facilitating in organizing a lottery of any kind, in any manner, organized by such State in accordance with the provision of the Lotteries (Regulation) Act, 1998.

The definition of ‘service’ with effect from 1.07.2012 excluded “transaction in money or actionable claim” and lottery tickets were actionable claims as held in the judgment of Sunrise Associates (supra). But Explanation 2 is proposed to be inserted now wherein it has been clarified that the expression “transaction in actionable claim” will not include “any activity carried out, for a consideration, in relation to, or for facilitation of, a transaction in money or actionable claim, including the activity carried out (a) by a lottery distributor or selling agent in relation to promotion, marketing, organizing, selling of lottery or facilitating in organizing a lottery of any kind, in any other manner”.

This insertion is clearly targeted to render the judgment in Future Gaming Solutions (supra) infructuous. However, there continues to be several grounds on which this provision can be challenged.

(i) This provision is still hit by a lack of legislative competence given that taxes on betting, gambling and lottery fall within the ambit of the State List under entries 34 and 62 of the State List and the Union cannot resort to Entries 40 read with entry 97 to levy service tax.
(ii) The transaction is solely that of sale and purchase of lottery ticket. There is no element of any service.
(iii) Another issue with regard to this levy is the manner of valuation. For e.g. the State sells the ticket to distributor at Rs 0.70/-. The Distributor sells it at Rs 0.71/- to the next stockist in line and that way finally the ticket is sold for Rs. 1/- to the final buyer. The demand of service tax is generally on Rs. 0.30/- instead of Rs 0.01/- (wherein Rs 0.01/- is the actual margin of the principal distributor).

Valuation is thus patently erroneous as the assessable value is the difference between the price at which the ticket is sold to the final consumer and price at which the State Government sells to the principal distributor. The margin of the principal distributor is only limited to his immediate sale to the next person in line.

In light of the above, it appears to be only a matter of time before this attempt of the Government to levy service tax on lottery also runs into a constitutional and legal challenge.

*This article originally appeared in Tax Sutra