Can’t weaponise taxation against goods from other states, says SC

New Delhi: The Supreme Court has reiterated that taxation cannot be weaponised to discriminate between locally manufactured goods and similar goods imported from other states, as it struck down a 2007 Rajasthan government notification granting value-added tax (VAT) exemption to certain local products.

The March 9, 2007 notification had exempted VAT on asbestos cement sheets and bricks manufactured within Rajasthan if they contained at least 25 per cent fly ash. However, similar goods produced outside the state but sold in Rajasthan were taxed, giving local manufacturers a price advantage. Out-of-state producers challenged the move as discriminatory. A bench of Justices B V Nagarathna and K V Viswanathan held that the notification violated Article 304(a) of the Constitution. The provision allows states to tax goods imported from other states but bars discriminatory treatment vis-à-vis locally made products.

Clarifying the principle of when differentiation becomes discrimination, the court said taxation would not be deemed discriminatory if a state does not produce similar goods or if the tax burden falls equally on both local and imported products. States, it noted, are free to design fiscal regimes to ensure parity, but the equality of burden must be tested in each case.

The bench added that limited incentives such as rebates or set-offs, granted in a non-hostile manner to promote backward regions, would not fall foul of constitutional provisions.

The Rajasthan HC had earlier upheld the notification, citing the Supreme Court’s ruling in Video Electronics Pvt Ltd vs State of Punjab, which allowed certain tax exemptions that did not directly restrict trade and commerce. In that case, the apex court observed that sales tax had only an indirect effect on trade and did not impede free movement across India.

However, the present bench distinguished Rajasthan’s notification from Video Electronics. It said the exemption was structured to benefit only locally manufactured products, thereby excluding similar goods from other states that used comparable fly ash content.

The SCobserved: “If the notification had stipulated that products using fly ash sourced from Rajasthan—whether manufactured inside or outside the state—would qualify for exemption, there would have been no discrimination. Both sets of goods would have contributed to the use of Rajasthan’s fly ash.”

Since the exemption was instead limited to locally made goods, the court concluded that it clearly violated Article 304(a). “We have no hesitation in holding that the impugned notification is discriminatory in nature,” the bench ruled, quashing it.

The verdict reaffirms the constitutional mandate that while states enjoy fiscal autonomy, they cannot design tax regimes that shield local industries from competition by disadvantaging goods lawfully brought from other parts of the country.