The Doctrine Of 'Manifest Arbitrariness' Applies To Invalidate Tax Statutes

The Delhi High Court held the third proviso to Section 254 (2A) of the Income Tax Act to be violative of the non-discrimination clause of Article 14 of the Constitution of India and, therefore, struck down that part of the said proviso, which did not permit the extension of a stay order beyond the period of 365 days even if the assessee was not responsible for the delay in disposal of the appeal by the Appellate Tribunal. In appeal, the Supreme Court in DCIT v. M/s. Pepsi Foods Ltd. upheld the judgment of the Delhi High Court. However, while affirming the judgment of the Delhi High Court, the Supreme Court gave two separate reasons for holding the third proviso to Section 254 (2A) of the Income Tax Act to be violative of Article 14 of the Constitution of India.

The first reason given by the Supreme Court was on the line of reasoning adopted by the Delhi High Court. That is, the third proviso to Section 254 (2A) of the Income Tax Act was violative of the non-discrimination clause of Article 14 of the Constitution of India, inasmuch as, it treated unequals equally and that the object of the said proviso was itself discriminatory. The second reason given by the Supreme Court, and which is relevant for the present discussion, was that the third proviso to Section 254 (2A) of the Income Tax Act was 'manifestly arbitrary'. In this context, the Supreme Court applied the doctrine of 'manifest arbitrariness', revived by it in the celebrated Triple Talaq case, to strike down the third proviso to Section 254 (2A) of the Income Tax Act as being violative of Article 14 of the Constitution of India. To appreciate the Supreme Court's application of the 'manifest arbitrariness' doctrine, it is first necessary to spell out the scheme of Section 254 (2A) of the Income Tax Act and, in particular, its third proviso, which was applicable in the present case.

Section 254 (2A) and its third proviso:

Section 254 of the Income Tax Act deals with 'Orders of Appellate Tribunal'. Sub-section (2A) thereof, as applicable in DCIT v. M/s. Pepsi Foods Ltd., incorporated a directory provision for disposal of appeals by the Appellate Tribunal along with its provisos, which are set out below:

"254. Orders of Appellate Tribunal.

(1) …

(2) …

(2A) In every appeal, the Appellate Tribunal, where it is possible, may hear and decide such appeal within a period of four years from the end of the financial year in which such appeal is filed under sub-section (1) or sub-section (2) of section 253:

Provided that the Appellate Tribunal may, after considering the merits of the application made by the assessee, pass an order of stay in any proceedings relating to an appeal filed under sub-section (1) of section 253, for a period not exceeding one hundred and eighty days from the date of such order and the Appellate Tribunal shall dispose of the appeal within the said period of stay specified in that order:

Provided further that where such appeal is not so disposed of within the said period of stay as specified in the order of stay, the Appellate Tribunal may, on an application made in this behalf by the assessee and on being satisfied that the delay in disposing of the appeal is not attributable to the assessee, extend the period of stay, or pass an order of stay for a further period or periods as it thinks fit; so, however, that the aggregate of the period originally allowed and the period or periods so extended or allowed shall not, in any case, exceed three hundred and sixty-five days and the Appellate Tribunal shall dispose of the appeal within the period or periods of stay so extended or allowed:

Provided also that if such appeal is not so disposed of within the period allowed under the first proviso or the period or periods extended or allowed under the second proviso, which shall not, in any case, exceed three hundred and sixty-five days, the order of stay shall stand vacated after the expiry of such period or periods, even if the delay in disposing of the appeal is not attributable to the assessee."

(Emphasis supplied)

From a bare perusal of the above extract, it is clear that Section 254 (2A) of the Income Tax Act incorporated a directory provision as far as the disposal of appeals by the Appellate Tribunal was concerned. This is evident from the words "where it is possible" and "may hear and decide such appeal" used in the main body of Section 254 (2A) of the Income Tax Act. Further, the first proviso to Section 254 (2A) recognised the 'ancillary' power of the Appellate Tribunal to grant stay in deserving cases, and stated that the Appellate Tribunal may pass an order of stay for a period of 180 days, in which case, the Appellate Tribunal had to dispose of the appeal within the said period of stay.

In the event, the Appellate Tribunal was unable to dispose of the appeal within 180 days, i.e., within the said period of stay, the second proviso to Section 254 (2A) kicked in, and empowered the Appellate Tribunal to extend the period of stay on being satisfied that the delay in disposal of the appeal was not attributable to the assessee. However, as the plain reading of the language of the second proviso shows, the period of stay so extended or allowed by the Appellate Tribunal could not exceed the period of 365 days in total, within which period the Appellate Tribunal had to dispose of the appeal.

Taking this forward, in a case, where an appeal could not be disposed of by the Appellate Tribunal within the total period of 365 days, the third proviso to Section 254 (2A) applied. The effect of the said proviso was that the order of stay, as originally granted by the Appellate Tribunal under the first proviso and extended under the second proviso, stood automatically vacated even where the assessee was not at fault for the delay in disposal of the appeal by the Appellate Tribunal. It was this part of the third proviso (indicated by the underlined portion in the above extract), which caused immense hardship to assessees.

Application of the 'manifest arbitrariness' doctrine:

Keeping in mind the aforementioned hardship caused to assessees, the Supreme Court decided the constitutional validity of the third proviso to Section 254 (2A) of the Income Tax Act. The Supreme Court held that the said proviso was 'manifestly arbitrary' on two counts. First, the said proviso resulted in automatic vacation of a stay on the completion of 365 days even where the Appellate Tribunal could not dispose of the appeal for no fault of the assessee. Second, such automatic vacation of stay in favour of the taxman would take place even where the delay in disposal of the appeal by the Appellate Tribunal was attributable to the taxman. In this regard, the relevant findings of the Supreme Court are set out below:

"17. Judged by both these parameters, there can be no doubt that the third proviso to Section 254 (2A) of the Income Tax Act, introduced by the Finance Act, 2008, would be both arbitrary and discriminatory and, therefore, liable to be struck down as offending Article 14 of the Constitution of India…Also, the said proviso would result in the automatic vacation of a stay upon the expiry of 365 days even if the Appellate Tribunal could not take up the appeal in time for no fault of the assessee. Further, vacation of stay in favour of the revenue would ensue even if the revenue is itself responsible for the delay in hearing the appeal. In this sense, the said proviso is also manifestly arbitrary being a provision which is capricious, irrational and disproportionate so far as the assessee is concerned."

(Emphasis supplied)

Consequences of the application of the 'manifest arbitrariness' doctrine:

As can be noticed, the Supreme Court in DCIT v. M/s. Pepsi Foods Ltd. was concerned with a procedural provision in a tax statute i.e., the third proviso to Section 254 (2A) of the Income Tax Act. Accordingly, the grounds of 'manifest arbitrariness' raised for challenging the vires of the said provision and which were subsequently accepted by the Supreme Court were procedural in nature.

In this context, an interesting question arises, i.e., whether the doctrine of 'manifest arbitrariness' can be used to challenge a substantive provision in a tax statute and, therefore, substantive grounds of 'manifest arbitrariness' can be raised to challenge the vires of such provision. To take a simple example, a substantive provision in a tax statute prescribes different rates of tax on identical products i.e., soft drinks, 10% on Coca-Cola and 20% on Pepsi. Can such a provision be challenged on substantive grounds of 'manifest arbitrariness' under Article 14 of the Constitution of India i.e., the prescription of a higher rate of tax on Pepsi is capricious and irrational. This question has been answered in the affirmative by the Supreme Court in DCIT v. M/s. Pepsi Foods Ltd.. In fact, in an earlier part of the judgment, the Supreme Court had this to say:

"14. It is settled law that challenges to tax statutes made under Article 14 of the Constitution of India can be on grounds relatable to discrimination as well as grounds relatable to manifest arbitrariness. These grounds may be procedural or substantive in nature. Thus, in Suraj Mall Mohta and Co. v. A.V. Visvanatha Sastri (1955) 1 SCR 448, this Court struck down Section 5(4) of the Taxation on Income (Investigation Commission) Act, 1947 on the ground that the procedure prescribed was substantially more prejudicial and more drastic to the assessee than the procedure contained in the Indian Income Tax Act, 1922. Section 5(4) of the aforesaid Act was thus struck down as a piece of discriminatory legislation offending against the provisions of Article 14 of the Constitution of India."

(Emphasis supplied)

The aforementioned observations of the Supreme Court leave no room for doubt that a substantive provision in a tax statute can be challenged on grounds of 'manifest arbitrariness' under Article 14 of the Constitution of India. Obviously, the grounds of 'manifest arbitrariness' for challenging such substantive provision will be substantive in nature.

Thus, the law declared by the Supreme Court in DCIT v. M/s. Pepsi Foods Ltd. is truly remarkable. It clarifies the law that substantive provisions in tax statutes are not immune from challenge on grounds of 'manifest arbitrariness' under Article 14 of the Constitution of India. The consequence of this is that the doctrine of 'manifest arbitrariness' can be invoked by assessees for challenging myriad types of substantive provisions in both direct and indirect tax laws. These substantive provisions can range from provisions which prescribe a higher burden of tax on certain goods, products and/or commodities to provisions which retrospectively amend the law and impose tax. In fact, even in the area of international tax, the doctrine of 'manifest arbitrariness' can be invoked by a foreign company to challenge a specific substantive provision inserted in the Income Tax Act by the Finance Act, the effect of which is to 'unilaterally' override beneficial provisions of Double Taxation Avoidance Agreements bilaterally negotiated between India and other countries. This is because the protection of the 'equality' clause enshrined in Article 14 of the Constitution of India extends to all 'persons', including juridical persons i.e., companies, irrespective of whether they are incorporated in India or overseas.

To conclude, the decision in DCIT v. M/s. Pepsi Foods Ltd. marks a tectonic shift in the approach of the Supreme Court in matters relating to constitutional validity of tax statutes. However, one caveat needs to be added here. The doctrine of 'manifest arbitrariness' under Article 14 of the Constitution of India is a doctrine of a very subjective nature. What might be 'manifestly arbitrary' to one Judge might not be so to another. Nevertheless, let's hope that with this decision, Constitutional Courts in India will test the validity of both statutory and procedural provisions in tax statutes on this basis and, thereby, contribute towards developing the jurisprudence of this doctrine.

Views are personal.

The author is an advocate practicing at the Allahabad High Court & Supreme Court of India.